Before you get yourself immersed into this realm of Forex trading, you need to be very well aware of the basics that come into play.
As the topic suggests, this article is solely dedicated to “What Leverage is in Forex Trading and how it impacts Risk Management and various Trading Styles?”
Leverage - an Overview
Leverage is basically the borrowing of money when one is investing in a currency, stock, or bond. The foreign exchange market uses the idea of leverage, where Investors can take much larger stakes in a currency by borrowing money from a broker and using that money to carry out future trades.
Consequently, leverage amplifies the rewards obtained as a result of a profitable trade and can also magnify losses in the same way. Hence, it is often called the “double-edged sword.”
How Does Leverage Work in the Forex Market?
Leverage is a tool provided by the foreign exchange markets to its investors to maximize their trading results. Most of the brokers that the Forex traders sign up for offer a wide range of leverages to choose from according to your risk management techniques and trading styles.
When dealing with new traders, certain brokers may initially restrict the amount of leverage used for a particular trade.
Still, in the majority of the cases, traders can customise the amount or size of the trade based on the leverage they aim for. However, the broker will need that “initial margin,” which is a percentage of the trade's amount that must be held in cash in the account.
Leverage Ratios and Margin Requirements
The leverage ratio illustrates the extent to which the size of the trade might be multiplied as a consequence of the margin that the broker keeps. For example, if the leverage ratio for the trade is 100:1, it shows how an investor can trade $100,000 in a particular currency pair for just a $1,000 deposit.
The margin for this trade would be 1%, as the broker would expect the investor to have at least a 1000$ deposit in the account for a 100,000$ worth of trade.
Leverage Forex Trading Tips
- It is essential to implement “stop losses” when trading with leverage to protect your capital from a huge loss. When markets are exceptionally volatile, the possibility of negative slippage can be eliminated by using guaranteed stop losses. “Take profit” can work in a similar yet positive fashion
- Try to keep the leverage to a minimum. Most brokers do not allow beginners to use a leverage of no more than 10 percent
- A margin call can be quite an alarming situation. To avoid getting a margin call, you should familiarise yourself with the Forex broker's margin policy
Summing it Up…
Forex trading comes with numerous advantages and disadvantages. The same is the case with the use of “Leverage,” as it can turn out to be extremely good for your trading journey or can impact it negatively by multiplying the adverse effects by the leverage ratio.