Leverage in forex trading is using borrowed funds to enter a transaction. It increases your financial position when it comes to forex trading without depending on your cash in hand. It is a powerful tool and helpful feature for forex trading because you virtually live on borrowed money. One of the reasons forex trading has become very attractive is that you can usually get much higher leverage than trading in stocks. At the same time, you must remember leverage is like a double-edged sword because the magnitude of profit or loss can be amplified depending on the trade. Leverage can make or break your forex portfolio because you are trading on funds usually provided by a broker.
If you like to start trading in the forex market, you can compare forex brokers online and finalize a trusted and reliable forex broker for your business.
This article will look at some of the benefits of trading forex with borrowed capital and the impact of leverage on your trading strategy.
Before splashing your funds on forex trading, you must keep in mind that you are living on borrowed money. It does not mean you have to be wary of investing the money you have borrowed. You must know how to manage your funds to profit from relatively small price changes in currency pairs. Taking a hands-on approach to your trade is essential because you must handle leverage with utmost care like any sharp tool. Once you have learned the ropes on how to leverage, then you don’t have to worry.
Leverage involves borrowing a certain amount of funds, usually from a broker. You are in a position to control vast amounts of capital because forex trading offers high leverage for an initial margin which you can calculate by dividing the total transaction value by the amount of margin you are required to invest.
The leverage ratio in forex trading can soar as high as 100:1. It means that for every Rs 1,000 in your account, you can trade up to Rs 100,000 in value. Forex market makers offer such high leverage because the risk is a function of trading. Remember the adage, the higher the risk, the greater the return. It is not a blind gambit if you properly manage the account, and otherwise, they would not offer the leverage. Also, entering and exiting a trade is much easier in forex markets than in less liquid markets.
You can monitor currency movements in pips in forex trading, which is the minor change in currency price depending on the currency pair. These movements are just fractions of a cent. It is why currency transactions must be carried out in significant amounts, allowing you insignificant price changes into huge profits magnified through leverage. When you deal with a large amount, small changes in the currency can result in substantial gains or losses.
However, it would help if you were wary of excessive leverage, although it has the potential to enlarge your profits or losses in greater magnitude. The higher the leverage, the greater the risk you will have to bear. At excessively high levels, leverage has another effect. In addition to simply magnifying profit and loss, it begins to damage your chances of success on any particular trade materially. Excessively high leverage may also distort the probability of your business being successful because of transaction costs or its lack. Transaction costs could change this picture, presenting a hurdle between you and profitability.
Leverage allows you to take strong positions on key currency pairs without investing excessive capital and magnifies the size of any profits you might make. However, the downside of leverage is it can be dangerous and can amplify your losses if you are wrong about a trade.
It can be a potent trading tool if you understand how leverage works. Margins can multiply your returns on successful trades since you calculate profits using the total value. Leverage allows you to gear up for other opportunities by freeing up capital that you can use for other investments. You can benefit from market movements by using leverage, known as going short.
Though leverage provides traders with a vast range of benefits, it is a potential downside. For instance, margins magnify losses and profits. You can easily forget the amount of capital you are placing at risk since your initial investment is relatively more minor than conventional traders. So you should always consider your trade-in terms of its total value and take steps to manage your risk. Your broker may ask you to shore up additional funds with margin calls to keep your trade open. There will be funding charges since you are effectively getting the money to open the entire position at the cost of your deposit.
Accessibility to global brokers and the proliferation of trading systems have promoted forex trading in the form of leverage accounts. Although leverage offers a high degree of reward and risk, it allows the trader to take on more positions than they could have with their capital alone.
However, the number of capital traders have at their disposal will significantly affect their ability to make a living. Putting more capital to work and replicating profitable trades separates professional traders from novices. Just how much capital a trader needs differs, but as a thumb rule, traders should not risk more than 1 percent of their own money on a given trade. While leverage can magnify your investment, it’s prudent for less-experienced traders to adhere to the 1 percent rule.