Leverage is capital that you borrow from a broker to invest in your trades. The concept of leverage is more common in forex trading because of short-term investments. When you borrow money, it opens up new opportunities for you to secure your position in the market. Just as leverage can magnify your profits, it can enhance losses as well. Therefore, traders should utilize leverage with proper strategies.
How does Leverage work?
Leverage is a notional loan for short-term trades. Traders consider it a notional loan because they do not receive it in physical form. The broker extends the loan in your credit line so you can invest in foreign trading. The leverage includes security, which you can refer to as a margin. Despite trading with 100% capital, you can trade at more than thousands of percent on your exposed capital. You must meet the condition of returning a portion of the leverage after the transaction closes. Returning the leverage is an automatic process.
Advantages of Leverage in Forex
When trading in foreign exchange, the leverage may or may not damage your career. Leverage is the additional capital you receive over your capacity. It implies that failing to trade with a proper strategy will maximize your troubles. At the same time, there are various advantages encouraging traders to depend on leverage. Let’s take a look at these advantages:
The first benefit of leverage is that it increases your opportunity to trade. You can trade more with minimum effort, increasing your chances of making a profit. No matter what instruments you are trading or the amount you are investing, you can multiply your stakes with the help of leverage- it can boost your capital by a hundredfold.
Apart from increasing the amount you invest in foreign exchange, it increases the money you can stack on each transaction. For instance, if you generate $100 in two days, leverage will help you gain the same amount in lesser time. So leveraged investments not only enable you to achieve more profits in less time, but they also provide a short-time return on investments.
The foreign trading market is interesting because of the high volatility rate. Volatile markets have more opportunities for traders to make a profit. As the market is consistently fluctuating, traders can invest in more instruments. Leverage plays a significant role against low volatility by enhancing the positions of the traders. This way, they can trade more instruments, making the market unstable.
Disadvantage of Leverage
You should keep in mind that leverage will not always work with you. Hence, you have to plan your strategies to minimize risk management on your investments. Consider these disadvantages before you depend on leverage entirely:
It is clear until now that leverage will increase your ability to make new investments. But just as you make immense profits, you have to bear a few losses. The losses on leverage are significantly more in contrast to unleveraged investments. For instance, if you have a 0.1% loss on $20,000, leveraged 100:1, it will be equal to a 10% loss on $200 without the leverage.
The leverage part of your investment will always be a liability, and you have to meet that amount by the end of the day. No matter what position you’re in at the day’s close, you have to meet the cost of the leverage. This automatic liability means that you will eventually encounter a lot of problems.
Professional traders do not trade with high leverage. When your leverage is low, you can protect your capital even if you make mistakes and can’t maintain consistency in returns. According to experts, 10:1 or 20:1 leverage is ideal. Regardless of what your broker has to offer, you can easily trade with this type of leverage. Deposit more money in your account and limit your trades. You can stay in the game for longer if you know when you can use leverage. However, this requires experience and a better understanding of the market.