There are several strategies to maximize one’s return from forex. Leverage is one such popular approach. Here is a simple example to describe what leverage in forex is. It is the practice of borrowing a loan from one’s broker to trade a large position that one cannot afford to do using one’s money alone. What is leverage in forex might seem like a complicated topic but it isn’t.
Leverage is spoken about in terms of ratios. If the leverage ratio is 1:100, one can control a $100,000 position with a meagre $1000 in one’s account. This bare minimum is also called the margin. The broker covers the rest of the money required to control the large position.
Why leverage is profitable?
Without this approach, the trader can only control those positions that the amount in the account allows. Consider a trader investing $100,000 of their own, and seeing an appreciation of $101,000. That would be a 1% return. Nobody engages in forex trade for such meagre returns.
On the other hand, consider investing only $1000 and being able to control a $100,000 position. Here, there is a 100% return. As it is the kind of returns that forex traders expect, leverage is a popular method.
Risks one must be aware of
Leverage is a popular strategy indeed. But it is not a bed of roses. It can perhaps be a double-edged sword. Many excited newcomers become victims of over-leveraging. Not planning the ratios properly can damage one’s account and turn out to be disastrous rather than rewarding.
It is possible to lose the entire investment in a single market move. Newcomers are advised to open a live account to get a real glimpse of the market rather than working on a demo account. One can understand how leverage affects the account and how the trader’s mind works while applying leverage.
Mitigating the risks
Despite the risks and the double-edged nature of the strategy, it remains a popular tool. It is because there are ways to mitigate the risks.
One must establish a trading plan and stick to it. One must not risk more than 2% of quite on a single market move. This lowers the risk. On the other hand, if the trader allowing the winning trades to run, they can consistently get profits.
Traders may have access to high leverage ratios. But it does not necessarily mean that the trader must max out the margin on a single move. One may use a calculator tool to compute a suitable amount to stay within the 2% risk factor.
The final word
For the new traders, leverage can seem like an exciting idea to scale up the profits in a limited number of moves. But the key is to not give in to the temptation without regarding the leverage ratio that one is dealing with.
Leverage by itself will not make a trader rich within seconds. Proper planning and following an effective risk management strategy are essential. In leverage, there is no specific right or wrong ratio. It is all up to the trader’s discretion – which one can develop with experience.