By M. Faulkes – Lots of people new to trading get confused by the concept of leverage in Forex, how it is calculated and how it should be used. If you are just starting out trading, you should approach leverage with caution because this very powerful tool can also work against you.
The Basic Concept:
A standard trading account with a regular broker will usually deal in lots of $100,000. To make a single trade with your account, you are going to need $100,000 to place on it. This figure is beyond the reach of most of us, and so this is why brokers offer leverage.
The way leverage allows us to trade these large lots is by the brokers lending the trader most of the money involved, with the trader putting up a percentage of the trade as security. Should your trade move against you by more than what you gave the broker as security then you are out of the game and your money lost, should it move your way then you should make a good profit.
More Details On Leverage In Forex:
You will usually see brokers advertising leverage in the form of 2 numbers separated by a colon, e.g. 100:1. In this case, the figures mean the broker is willing to let you trade with only 1% security. Similarly, 200:1 means they are offering trades with only 0.5% security (1 / 200 * 100(%)) and so on. You may see brokers go as high as 400:1 (0.25%).
You may also see the word ‘margin’ used when leverage in Forex is talked about. The margin is the percentage of the trade which you provide as collateral against it, and it is always expressed as a percentage. In the case of 100:1 leverage, the margin is 1%. Forex margin trading and leverage trading are generally used interchangeably to refer to the same thing.
Leverage In Use:
From the examples above it should now be clear that leverage could allow you to borrow $99,000 form your broker to make a $100,000 trade, with only $1000 of your own money at risk. As mentioned previously though, your trade will get closed by your broker if it falls by the $1000 security you used. Once your $1000 is wiped out, the broker isn’t going to risk his money on your trade if it continues to fall.
Because you traded with a 1% margin, you couldn’t afford your trade to drop by more than 1%. The Forex market is a highly volatile one, and movements of 1% are common. Your trade may have turned around and made a profit after it dipped, but your trade was already gone. Your small margin for error meant you lost your stake because your broker had to close the trade too early, this is commonly referred to as being too heavily leveraged.
Avoiding Small Margins And Heavy Leveraging:
Follow this link to learn more about forex trading strategies that don’t put you at risk of being too heavily leveraged, which is vital in protecting your trading account.
Many traders are using leverage as a way of controlling large lot sizes without the full investment, because they have learned to use it responsibly and to their benefit.
Interested in automated trading strategies?
Learn more about automated forex trading with the Forex Megadroid Robot.
Discover more about the MegaDroid Robot and automate your trading.