It’s no secret that the currency pairs market, out of all the marketplaces on the stock exchange, has the most risk. This is due to currencies’ complete reliance on all factors. In spite of this it is hard to imagine it without such a tool as leverage. Now we’ll show you how to use it correctly.
When a trader enters a trade, leverage is money provided by a broker to help boost the trader’s finances. Even with a tiny balance, it is possible to open huge positions.
Forex can bring both the joy of victory and the sadness of loss. The use of leverage can give good profits as well as symmetrically large losses.
A trader utilizes leverage to borrow money from a company in order to make a large trade with less of his own cash. The trader only needs to invest a small quantity of money. Leverage is the ratio between the required amount of investment and the cost of placing an order. Margin trading is the term for this form of trading.
The best ways to use leverage in forex trading
1) Decide on the size of your leverage
If you don’t have a clear trading plan or enough experience, you should avoid utilizing too much leverage. You should not expect to become wealthy every time you use this technology. Brokers regulated by European regulations can provide leverage of more than 1:30, while those registered offshore, which is the most prevalent, can provide leverage of 1:2000.
2) Choose the right lot size
For example, if your balance is $1000 and you plan to trade EUR/USD, the opening price is 1.1820, and the value of this currency pair reaches 1.1830, the difference will be 10 pips, resulting in a profit or loss of $100 on your balance. If you employ leverage, you can open a total of 20 lots with a possible profit or loss of $2,000 each lot.
If you open a small lot, the risk will be limited to twenty dollars.
3) Use Stop Losses
Because the market is very dynamic and operating with leverage can quickly go to zero, you must use limit stops to restrict your losses when the market goes against you. That is, if the market moves against you, the deal will be instantly closed. It is feasible to limit losses by using this tool. The use of trailing stops will result in trade optimization.
4) Choosing a broker
The company that provides access to the financial market determines the speed with which transactions are completed. The lower it is, the lower the risk of slippage (the difference between the estimated and actual cost of opening/closing a contract). Even minor slippage can result in a loss when trading on margin. As a result, a stop loss is required.
A broker not working on the client side may have the ability to find a stop loss.
5) Intelligent risk allocation
Losses cannot be written off on leverage, most likely you had the wrong strategy and lack of risk management system. Let’s try to explain this with an example:
Imagine the situation, we have two traders, Robert and Michael. Each trader has 10,000 in his account. Robert opens a trade for 2,000 with a financial leverage of 1:20 with an initial margin of $20. Let’s say Robert sets a stop loss at 2.5 percent of the order opening level, his risks will be at $50 if the market turns against him. If expressed as a percentage, Robert’s risk will be at 0.5 percent of his trading balance.
Michael’s strategy is different, he chose higher leverage of 1:50, and he created an order with a margin of $5,000. He could control a $25,000 position with a $5,000 margin. His risk would be $625, a percentage of that is 6.25.
You can see that with an equal amount on the balance sheet, Robert is more grammatically managing his risk, even though Michael chose to leverage more.
How do I understand the term “purchasing power” when using financial leverage in trading?
It is an amount that is higher than what the player has in his balance sheet to trade the selected asset. The amount of leverage is in proportion to the buying power.
What does the term “coverage” mean?
The coverage is calculated by dividing the amount on the client’s balance by the amount of leverage. In other words, this is the amount of money needed to start a transaction on the targeted asset. It’s also known as a margin.
What does margin call mean?
If the margin level during a trade in progress approaches the minimum mark, the broker sends a signal to the trader to either deposit funds or release margin by closing a trade.
Is it worth using high leverage?
Here everything is individual and depends on risk distribution and experience. Just taking the maximum leverage is not a reason or a guideline to action. You need a more efficient management of funds, planning and analysis. For example, you can work with minimal volumes starting from the balance of $10000, it will lead to the risk of only 10 percent of the total balance, and one pip will cost a trader no more than $0.1.
Now it is hard to imagine trading on the currency pairs market without using leverage. It allows to gain maximum profit with small investments and without managing the risks it will not lead to fatal consequences. Choose your leverage size responsibly.