Trading with leverage has been one of the most popular options for risk-takers across the globe. Forex traders tend to get higher leverage than those trading stocks. That is also a reason why many traders are fond of Forex trading.
You might have come across the word “leverage” several times now. Most people out there have also heard the same word, but only a few know the real definition, how it works, and its pros and cons.
In the markets, it is feasible to use other people’s money to get involved in transactions. You can also use this concept in the forex markets. The word leverage could mean using the borrowed capital for trading. Forex programs and brokerages have been promoting how good the opportunities for leverage can be. But it does not mean that it is a great option for you. For those who haven’t comprehended the basic principle of leverage, I suggest you don’t try this, or you could end up with a huge debt that you can’t afford to pay. Below you find more why you should not trade with leverage.
Leverage: What does it mean, exactly?
Leverage is a method of investment whereby investors borrow money for particular investment products. In forex and stock trading, the borrowed capital comes from the brokerage. Forex trading, for instance, comes with high leverage for the margin requirement. In this case, the trader can control a huge amount of money.
It is actually simple and straightforward to calculate the margin-based leverage. It is imperative to divide the total transaction value by the amount of margin that the traders require to get up.
For instance, if the program requires you to deposit 1% of the total transaction value. A standard lot is usually equivalent to US$100,000. Therefore, you will need a margin of at least US $1,000. The margin-based leverage for that particular transaction is 100:1. If the margin requirement is 0.25%, the margin-based leverage will be 400:1.
It is critical to understand the precise opportunities in the margin-based leverage as described in the latter ratio.
This leverage, however, does not affect the risks. The margin does not influence profit or loss. But the real leverage will be the stronger indicator of profit and loss.
Calculating real leverage is also straightforward. You can simply divide the total face value of the open positions by the trading capital.
For instance, if you have $1,000 in your account, and you open a $10,000 position. You will be trading at 10 times the leverage of your current account. If you open two positions, that also means your leverage is 20 times.
In a nutshell, margin-based leverage represents the maximum real relevance that retail traders can employ. Most traders won’t use their entire accounts for the margin. Well, even if you are trading forex, you will want to put your eggs in different baskets. Real leverage must be different from margin-based leverage.
You won’t want to use all of the available margins. You must only use your leverage when you can reserve the opportunities for profit.
The potential loss of capital should be considered thoroughly before proceeding. Normally, the experts would recommend that the loss should never be more than 3% of the trading capital.
If the particular position is leveraged to the huge potential loss of 30% of the trading capital, then the leverage should be reduced to the same percentage. The general guideline is 3%. But the traders will have the freedom to manage their risks.
One will need to calculate the exact level of margin that they are using.
Traders can choose how much margin they require. Assume you have $10,000 and wish to trade ten micro-lots of USD/JPY. When ten minis are traded, a pip costs about $10.00.If you trade 100 minis, each pip shift is worth $100.
A 30-pipe failure results in a $30 loss for each mini lot, a $300 loss for each ten mini lots, and a $3000 loss for all mini lots. Even if you have the financial means to purchase more, you should limit yourself to 30 mini lots with a $10,000 account and a maximum risk of 3% on each trade.
Leverage in the forex market can reach a maximum of one hundred to one. For every $1,000 in your account, you can trade up to $100,000. Many traders see Forex market makers as a critical lever when risk is a factor. Naturally, they recognize that risk may be minimized through effective account management. Furthermore, the large and liquid currency cash markets provide for proper transaction entry and exit.
We monitor currency changes in pipes since their currency values fluctuate the least. This is a minor modification. For example, the GBP/USD currency pair fluctuates by 100 points, or one cent, between 1.9500 and 1.9600.
As a result, currency transactions must be significant enough to transform modest price changes into higher profits when applied. With a $100,000 total investment, even modest currency swings might result in big gains or losses.
Leverage trading dangers
If you do not manage your risk appropriately, you may lose more money by utilizing leverage than you initially invested.
Increasing your purchasing power by a factor of two, for example, doubles both your income and loss. Investing in a stock that loses more than half of its value will result in a loss of more than 100% of your initial investment.
Furthermore, your broker may place a margin call on your account. If the value of your account falls below a certain level, you may be allowed to ask your brokerage company for an additional deposit. If the value of your investments continues to fall, your broker may be worried about your capacity to repay the loan.
If you fail to meet a margin call, your broker may sell your shares to recoup their financial losses. In addition, your broker has the ability to raise margin requirements at any time.
