Leverage is a trading technique which involves the usage of borrowed money to trade a currency, security or stock. However, leverage is the most commonly used concept in forex trading as compared to others. By borrowing funds from brokers, the traders can open large positions in the currency pair. Consequently, leverage can magnify the profits from favorable movements in the rate of a currency exchange. Many experts consider leverage as a double-edged sword, thus, it can magnify losses too. Therefore, it is vital that traders understand how to keep leverage under control and have suitable risk management strategies to mitigate the potential losses in forex trading.
The forex market is one of the largest markets in the entire world where currency exchanges worth $5 trillions occur every day. Forex trading refers to the process of buying and selling the currencies with the main objective that the rate moves in favor of the investor. These currency rates are presented as bid and ask prices. The price at which the currency is bought is known as ask price, and the price art which it is sold refers to as bid price.
One can say that leverage in forex trading gives the traders the power to manage something big with something so small. For newcomers, the forex market might appear boring, which moves at a snail’s speed. Hence, the forex market is slow, especially when you compare it with the stock market. However, leverage is something that makes the forex market the most opportunistic market that can make you rich. Leverage works on the principle that you don’t have to “be rich” to become rich. It is the best way to generate unlimited wealth in the forex market.
Video Source : Trader’s Guide
Many traders use leverage to maximize the profits from forex trading. Thus, the forex market is one of the markets where the leverage is the highest. In simple terms, leverage refers to a loan offered to a trader by a broker. Some brokers might limit the leverage amount for novice traders, while others do not hesitate to offer high leverage to their clients. These brokers are often known as high leverage forex brokers. Although leverage enhances the ability to earn significant profits, it can also work against traders. If the currency involved in one of the trades moves opposite to what you would have believed, leverage will magnify your losses. To prevent it, forex traders have to implement a strict trading strategy, such as stop-loss orders to minimize potential losses.
Also Read: Pros And Cons Of Trading Forex
What is the Best Leverage Ratio for Forex Beginners?
Undoubtedly, leverage is one of the main attractions of the forex market. Without it, investors might have to wait for several months to see even a 10% change in his position. As attractive as leverage may seem, it is indeed a risky strategy. Here are the three rules to keep in mind to choose the best leverage ratio:
- Always begin with low leverage when trading forex
- Always utilize a stop-loss order to safeguard your funds and minimize your losses
- Always keep a maximum of 1%-2% of your capital as leverage for each trade
How to Manage Leveraged Risks?
We all know the phrase, “With great power comes greater responsibilities”. This particular phrase genuinely applies to the forex market due to the higher application of leverage. Leverage can be a boon if the market is in your favor, but it can soon turn into a nightmare if the market moves against you. However, it does not mean you should not try forex trading. All you need to do is to have a risk management strategy in place such as employing stop-loss on every trade.