In comparison with other investment methods, trading on the Forex market has a huge number of opportunities for investors and traders. One of the reasons why the Forex market has become so popular is that most brokers provide leverage. Advantages of leverage are numerous. Of course, pitfalls should not be ignored.
Experienced traders know all the advantages and disadvantages of leverage. Unfortunately, beginners often do not pay any attention to this and begin to trade real money without basic knowledge of what is leverage and how it works in the Forex market.
Leverage affects risk and profit which means it is very important to understand what it is and how it works.
Identifying forex trends for beginners
What is leverage?
In simple words, you borrow money from a broker to trade. In order to trade in the Forex market you need an initial margin, and therefore brokers offer a large leverage. Leverage increases your capital by 100 or more and allows you to control an amount that you do not actually have!
Related: How to Trade Using Fibonacci levels
How big can a leverage be? What are the advantages of leverage?
Leverage is a flexible tool and you can choose your own leverage depending on your desire, financial position, trading strategy, money management.
To earn money in the Forex market, traders need leverage. Leverage ranges from 10: 1 to 200: 1, although some brokers offer even 1000: 1!
Let’s look at an example:
If you have opened an account with $ 1000, and your leverage is 100: 1, then you can actually trade with $ 100,000. That is one of the advantages of leverage. When you manage a large amount of money, even small fluctuations in prices can make a huge profit, and of course as quickly you can get a huge loss.
What is the risk of using leverage?
Leverage can significantly increase your profits, but at the same time, it also increases potential losses. The higher the leverage, the more money you have to trade with. This means either bigger profits or bigger losses will be made.
Too much is not necessarily good
It is important not to be greedy, so never trade the amount that you cannot afford to lose. A small leverage gives you relative flexibility and you can use a larger stop loss, on the other hand it will help you not to risk too much in one transaction, especially if you are trading on a real account.
If the price goes against your position a large leverage can literally “eat” your entire deposit in minutes. Be reasonable when choosing leverage and think about the risks involved.
It is not difficult to find plenty sad stories over the internet in which traders tell how they lost all their money using too much leverage.
Still not sure? Think about the economic crisis, investment banks traded with a leverage of 40: 1, which led to a banking crisis in the States. One of the causes of the crisis was the use of a large leverage to buy securities. Trading in the Forex market is a slow and weighted decision, not a chaotic trading in the hope of earning a million at the end of the month.
And the last question that surely spins in your head:
Why should a broker give free credit?
The use of leverage is really free. The fact is that the broker does not risk anything, the loan opens when the transaction is made and is returned immediately, as soon as you close the deal. You cannot withdraw this money or use them somehow in a different way. It is advantageous for a broker to offer it as he earns commissions after opening a deal and freezes a certain amount on your account, thereby insuring your risks.
We hope you enjoyed this article.