There is so much money to make in the forex market. Every day, foreign exchange transactions up to the tune of $5 trillion are carried out. If you are a new forex trader, putting all your eggs in one basket is a great risk. You shouldn’t use all your money as forex capital. However, using little capital means you will have to settle for lesser profits. So, how can you maximize profits in the forex market? This is made possible with the concept of leverage. Here’s everything you should learn about leverage in forex.
What Is Leverage?
In the simplest terms, leverage is a loan given by a broker to a forex trader. If you want to trade a massive volume of foreign currencies, leverage comes to the rescue. Borrowing money from your broker allows you to trade larger positions and take larger profits. But before a broker can lend you money in forex, you must meet a minimum requirement. And that requirement is to have a minimum amount of money in the forex market. Remember that no creditor will lend you money without having collateral in place. This works the same way in forex trading. In technical terms, such collateral is called margin. And your margin determines the leverage ratio.
How Does Leverage Work?
Leverage is usually expressed in terms of ratio, and the most widely used ratio is 100:1. Hence, if you use the ratio of 100:1, it takes that you can control $100,000 with a capital of just $1,000.
It’s best to learn the concept of leverage with practical examples. So, let’s get to it. If a trader has a capital of €10,000 with a leverage ratio of 100:1, his capital increases by 100 folds, which equals €1,000,000 (that is, 10,000 x 100). After finding a perfect entry for the EURUSD currency pair at 1.4055, you can put your take profit at 1.4155. That’s almost double your capital! I guess you can now see how profitable leverage can be.
How to Calculate Leverage
If you want to measure the leverage suitable for you, below is the general formula to use:
Leverage = 1/Margin = 100/Margin Percentage
Therefore, if the margin is 0.02, the margin percentage equals 2%. Therefore, the leverage here is calculated as 1/0.02 = 100/2. We, thus, arrive at a leverage of 50.
What Are The Risks Associated With Trading Leverage?
You must have heard that leverage is a two-edged sword. Of course, it is possible to make insane profits with leverage. On the flip side, leverage can also be your doom – you can lose all your money and be booted out of the market. Therefore, you should never overleverage.
Conclusion
Leverage is a plus only to patient traders. When traders lament that they have been liquidated, it is due to one factor – GREED! Just because another trader made huge profits using a particular leverage ratio does not mean you should follow suit.
Leverage is one of the most flexible concepts in forex trading. You can customize it to suit your strategy. If you want leverage to give you that big break, you should learn to manage risks. Accordingly, never forget to trail your losses. And above all, make sure to always keep small positions in forex.
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