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Leverage Trading in Forex – The possibility of trading leverage

Leverage in Forex
If you are a new trader in the forex market, you might be puzzled by leverage in forex trading and how useful it can be for traders. If you find yourself in such a situation, here is detailed content on what leverage trading is all about, the advantages and disadvantages.

Generally, leverage allows you to influence your trading amount without increasing your trading capital. In trading, it refers to accessing a larger portion of the market with smaller funds. Unlike traditional investment, where you must have physical funds, leveraged forex trading allows you to trade without any physical cash to open a bigger lot.

Today, leverage trading is a widely accepted concept and strategy a lot of traders use in trading. Corporations and institutional traders have the financial capability to open bigger trades that might take decades to open. However, brokers have simplified the process to allow retail traders to open trades beyond their initial capital.

How does Leverage Work?

You can see leverage as a short-term loan a trader takes from his or her broker, allowing such an individual to open a big lot with small capital. Theoretically, it means you don’t have the physical cash or the amount of money to open a position or trade size accordingly. However, your broker provides the needed funds for you to trade with your little amount.

Leverage gives you protection against exposing your capital, as the case is when using 1:1. However, it allows trading at different percentages of your exposed capital; then, you return the leveraged amount once you close the transaction. You don’t have to worry about how the calculation is done because it is automatic. It means that you keep the profit for every position while bearing the high risk of losing your trading investment if the market goes against your trading position.

Example of Forex Leverage

Assuming in one of your retail investors' accounts, your account balance is $1000 and has a leverage ratio of 1:100. You decide to open a buy position with the currency pair (EURUSD) with a volume of 10,000. Then the price you opened the trade is 1.0950 with a tight stop-loss order at 1.0850. Your forex margin requirement for this currency pair would be the price multiplied by the volume and the leverage ratio.

Mathematically, that would be as follows:

=1.095 X 10000 x1/100
=109.50

However, if you don’t want to go through the calculation stress, you can use a forex margin calculator, which is available online. Most brokers offer a calculator as one of the numerous tools traders can use in trading forex.

Nevertheless, if the price moves in an opposite direction, you can lose up to $100 because 1 pip value of EURUSD currency is equivalent to $1. It is $100 because of the difference between your entry price and your stop loss level. Furthermore, if you decide not to use a stop-loss, you will incur more losses, and your account can liquidate depending on your capital. Stop-loss is one of the best risk management tools to mitigate your risks when trade forex.

The Link between Leverage and Forex Trading

Leverage in forex trading makes other instruments look like a child’s play. In comparison, some derivatives might allow you to use a leverage level around 20:1 that is different in forex trading. Trading leverage ratios in forex can be in 100:1 depending on the forex broker. Because of this, leverage trading is more prevalent in forex trading compared to other financial instruments.

Leverage is the magnifying lens you need in trading that allows you to open bigger trading positions that your funds might not be capable of holding. Leverage incurs an expensive risk profit. However, when appropriately used, it can be a useful companion in forex trading.

Difference between Margin and Leverage

At times, traders tend to confuse the difference between margin trading and leverage trading. For some, they refer to the same thing. However, the margin is an essential concept to understand if you want to take your trading seriously. Margin is the amount of money you require to place or open trade and maintain that position before closing it. It is not a transactional cost you pay but a security deposit the broker holds for open trades.

However, leverage allows you to trade large position sizes using a small amount of money. For instance, if you have a leverage ratio of 1:50, it means you can control trade that is 50 times your initial investment. Leverage trading is a key component of financial derivatives trading, including CFDs trading and spread betting. You can use leverage on different asset classes, including commodities, indices, stocks, and CFDs. Remember, CFDs are complex financial instruments that have a lot of risks.

Potential of Leverage Trading

While leverage trading is a double-edged sword, it can offers benefits return to forex traders who understand how to use it to their advantage.

Leverage may create numerous advantages for any trader that can tame the wild beast of using it but can also be equally risky and make a trader end up losing.
  1. Increased Profit
Whether you open a buy or sell position, the primary purpose of that decision is to gain profit. Leveraged trading could allow you to earn more while investing a little capital. However, it can also be risky with making you lose everything. Irrespective of the instrument you trade, whether you are taking a large or little amount, the primary intention is to increase your profit from every trading position by multiplying the stakes.

You may also get the same result if you invest more funds or money. However, with leverage, you can go a step ahead as you artificially boost your available trading capital without adding any money to it. Leverage helps increase your trading funds by many hundreds of times.

Regardless of the complexities and why leverage is important, don’t allow anyone to downplay its role differently. Ultimately, traders in the forex market leverage to trade with lesser capital. It is all about raising their stakes to get more potential profit on the invested little capital in the forex markets.
  1. Increased capital efficiency
While leverage in forex can increase the amount of money invested, it can also increase your capital efficiency and so the risk too. To understand how that works, see your capital as an asset that can deliver a yield. Assuming you had a potential profit of $300 in three days with an unleveraged position, leveraging that same position will take you a shorter time to achieve. It means you can reinvest that capital and make a profit over time. From this perspective, leverage doesn’t only increase your profit but also increases trading capital efficiency.
  1. Mitigation against low volatility
Leveraged trading in forex helps in mitigating against low volatility. Trades that usually produce a high amount of profit are the volatile ones since the forex market moves in broader cycles than stable instruments. Because forex traders are cautious when trading currency pairs and the different factors that can affect price changes, volatility is usually low at the end of the scale.

Here is where leverage can become an advantage by allowing you to make bigger potential profits from smaller trading positions. However, it is equally risky and may end up making you loss everything. With a high leverage position, a small price change can make a huge difference as traders do everything to capitalize on these currency movements. Leverage is indeed a double-edged sword because when it is working, everything goes your way. However, it comes with a high risk of losing within the twinkle of the eyes.

Disadvantages of Leverage Trading

Despite the many benefits of leverage in forex, most traders face problems when they unsuccessfully dabble in forex leverage without understanding it. Most traders get greedy even with their little capital and make critical mistakes that will affect their trading. Leverage can work in both directions if wrongly managed.
  1. Heavier losses
The potentials of getting high profits comes with heavier losses if the positions you opened didn’t go your way. With a minimum 0.1% loss using a capital of $20,000 and leverage of 100:1 will incur a loss of $20, which is almost 10% of your trading balance. Therefore, forex trading leverage can result in losing more than you expected, but you can also make higher potential profits if you can bear the losses.
  1. Constant liability
Once you leverage your forex account, it is an immediate liability because there are additional costs you must pay whether the market goes up or down. You have to meet the principal cost of the leverage. The charges apply automatically from your trading account. Alternatively, you are handicapped by default when you enter a position; it doesn’t matter if the trading positions move toward zero; you still own your broker and must pay the borrowed trading amount.
  1. Financing Costs
If you think the troubles aren’t significant, you need to pay interest for the positions opened using leverage. The interest is calculated and is applicable daily depending on what your forex broker sets. These costs are applicable when you use high leverage in forex positions; regrettably, the costs can accumulate to act as an impediment when holding long-term trades.
  1. Margin Call Risk
Leveraged trading has the ever-present risk that you might fall below your broker’s margin requirement. The margin number is a set percentage for any position size you need to fulfill in your trading capital. However, if you fall below the required threshold, your broker will initiate a margin call on your account. Once that happens, your broker will automatically liquidate your portfolio if the funds cannot hold your trade.

When this happens, positions that would have run on profit are closed along with other liquidating positions. Eventually, margin trading is a constant risk due to leverage, which can affect your trading balance.

Leverage Trading with PrimeFin

PrimeFin allows traders to use leverage in the forex markets. Furthermore, leverage trading is also permitted in other financial instruments but limited to some assets. Remember using leverage has its demerit. You should consider the risk before leverage trading. PrimeFin has the quality trading tools for you to start your trading. To begin, you can follow the steps below:

  • Sign up for a trading account
  • Fund your account
  • Start trading

Why Trade with PrimeFin

PrimeFin is one of the leading forex exchange platforms that allows you to trade different tradable assets in the financial market. The broker has a track record of providing relevant trading tools and materials for its customers. Here are a few reasons to trade with PrimeFin:

  • Regulation: We are regulated to offer trading services to different financial asset investors. 
  • Educational Setup: We have diverse educational content services and resources for your trading.
  • Mobile Trading: You can trade anywhere you are. It doesn’t matter if you are far away from your laptop; you can still trade. 
  • Deposit and withdrawal option: We have a range of deposit and withdrawal options. Whether you want to fund your trading account via credit/debit card or bank transfer, we have got your back. Also, withdrawing your funds are very simple.
  • Trading Instruments: If you want to spread your portfolio by trading other financial instruments like commodities, iron, indices, or metal, we have you covered. We have more than 350 tradable assets listed on our platform. 

Frequently Asked Questions

What is the best leverage in Forex?

It is hard to determine the best forex leverage level to use as it depends on different factors. It can depend on the upcoming market moves, the trader’s strategy, and risk appetite. However, a general rule for the best forex leverage to use in forex is to use small leverage to keep your position open for a more extended period.

It is logical to take this approach since long positions are opened when traders expect significant market moves. Nevertheless, if you want to open the position as long as possible, avoid using stop-loss because of market fluctuations. Here, it would help if you did market research on the price of the asset to know how long to leave your position.

How does leverage work in forex?

Leverage amplifies the trading capital of a trader. In other words, leverage allows you to get 10, 50, 100, or 20 times your initial funds. The broker allows you to open a trading position that is X times your capital. For instance, if you deposit $2,000 and use a leverage of 1:200, it means you can open a trade worth $400,000 with your initial capital of $2,000.

What is a 1:500 Leverage?

When your broker offers you a leverage of 1:500, it means for everyone $1 of your capital; you receive $500 to trade with. For instance, you deposited $1000 with a leverage ratio of 1:500; you will either make a profit or loss of $25000 if your asset gain or loss 5%. Individual traders hardly use 1:500 because of the high risk involved. However, professional traders with knowledge, experience, and expertise use such leverage to assess their risks.

What is leveraging in Forex?

Leverage is part of the successful trading strategy for any trader that understands how the forex exchange market works. In the foreign exchange market, traders use leverage to increase their profit potentials from currency pairs' changes in the foreign exchange rate. Leverage allows you to trade or open bigger positions for a relatively small deposit in your account.

It magnifies your losses and profits when trading. For instance, you placed a deposit of $1000 with a leverage of 1:10, which means for every 5% gain, you get $500, whereas if you lose 5%, you also incur a loss of $500. However, when you don’t use leverage in your account, for every 5% gain or loss, it is $50

Conclusion

Trading CFDs or any financial assets, you should evaluate the risk before venturing in. However, leverage forex trading is an important concept that allows traders to take advantage of their little funds and open bigger positions. The margin represents the money you need to open a trade and maintain it. Notably, the margin isn’t a transactional fee but the deposit your broker holds while your trade is open.

When trading currency pairs on margin, you increase your exposure as you can open leveraged trading positions. Furthermore, margin allows traders to manage larger trades with a smaller capital. Today, forex trading on margin is a common strategy almost all traders use, even though it can magnify your losses.

If you are a new trader, you should understand how margin works before using leverage in a foreign exchange market. Understanding concepts such as margin call, maintenance margin, and margin level are essential to your trading.
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