Leverage Forex
Leverage Forex Profits to the Max
The leverage Forex brokers offer is what allows you to trade with a much larger contract value even though you only have a small deposit. Essentially, the broker lends you the money to trade. The advantage is that you can make substantial profits without risking too much of your capital.
The average leverage Forex brokers allow their customers to trade with is 200:1 while certain brokers even go to 500:1. This means that with a $50 deposit you can open positions worth $10,000. The benefit, of course, is that you are trading with $50 while making profits as if you were trading with $10,000 of your own money.
The Importance of Leverage
While the Forex market is extremely volatile, the price movements in absolute terms are tiny. For example, if the EUR/USD moves 100 pips that is only the equivalent of $0.01 in the change of the exchange rate. Without leverage Forex traders would be unable to make any significant profits due to these incremental movements.
In fact, these small movements in price, compared to other financial markets, are why brokers can afford to offer traders such high levels of leverage. Forex trading may be risky but without leverage it would not be as attractive as it is to retail traders as everyone would be struggling to make a few cents left and right.
The Risks of Leverage
While it’s true that without leverage Forex traders wouldn’t make anywhere near the profits they do, it is also true that leverage can be extremely risky. This is because, even though it might offer the potential for great profits, it also maximizes potential losses.
For example, if you open a $100,000 position in EUR/USD, using $500 of your deposit, you stand to make a profit of approximately $50 with a 50 pip gain. However, if the trade moves against you significantly you can find yourself losing $50 or even more, especially due to the volatility of the Forex market.
Initially, this may not seem like such a major risk. However, if you don’t manage your trades properly, you can easily find yourself losing your entire account balance in a single day. Remember that it is practically impossible for all of your trades to be winning ones and if you don’t set a stop loss that will limit your potential losses you can quickly find yourself losing more than you are making.
Leverage: Forex Trading for the Wise
Even though the absolute movements of currency rates on a day to day basis are incremental, due to leverage Forex traders can make a substantial profit. However, the wise Forex trader is clearly aware of the risks when trading with a high level of leverage.
This is why most brokers offer traders different options when it comes to the degree of leverage on their account. Of course, you will most likely be tempted to take the highest leverage available but this is the easiest way to lose your account. If you temper your enthusiasm by opting for a lower degree of leverage Forex trading will not only be less risky but you stand a greater chance of making a significant return because you can widen your stop loss. A wider stop loss will increase your chances of profitability because the volatility of the Forex market means that the market can often move against you quite a bit before it starts going in your direction.
Leverage is an incredible advantage but can also be extremely risky. This is why you need to remember that the high level of leverage Forex brokers offer is not always the best option.
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