Is Leverage an advantage in the Forex market?
Online forex trading is available to many traders, while every trader will have their reasons to trade Forex. And the leverage levels available in this market are one of the most popular reasons why traders choose to trade Forex.
If you are a beginner trader, you may be interested:
In this article, you will find a detailed overview, including an explanation of the nature of forex leverage and its advantages and disadvantages.
What does forex leverage mean?
What is forex leverage?
Leverage is an instrument that allows you to increase your ability to speculate or invest without having to resort to more significant funds from you.
With Leverage, a trader can open orders several times the value of equity.
What Leverage is in simple terms - Leverage is a way for a trader to trade in much larger volumes than they know, using only their trading capital.
When you have visited trading sites, you may have seen many screaming banners that offer something like 0.01 lot, ECN and 500:1 leverage. Not all terms are known to newcomers to Forex, so many people are curious to know what Leverage is.
Forex leverage is...
What is the Leverage a CFD broker provides to its client?
Many traders define Leverage as a line of credit.
It is not entirely accurate as the Leverage does not have precisely the same characteristics that are attributed to the credit. First of all, when you use Leverage, you do not think that you will need to pay back the credit.
You need to close your position or leave it open before it is closed with a margin call.
To sum up, Leverage is an instrument that increases the maximum position that a trader can open. Now that we have a better understanding of what Leverage is let us take a look at how it works by example.
How does the Leverage work?
Let's say a trader has $1,000 in his trading account. As a rule, one lot on MetaTrader 4 is equal to 100 000 currency units.
Since it is possible to trade mini lots and even micro-lots with Admiral Markets, a deposit of this size will allow the trader to open micro-lots of either 0.01 for one lot or 1000 currency units, without using Leverage.
However, since the trader will be looking for a 2% profit on each position, he will only be able to get USD 20. It is why many traders decide to use Leverage, and their trading position and profit can be higher.
What Does Forex Leverage Affect - Example
What does Forex Leverage 1:500 mean?
Suppose a trader has $1,000 in his account and he wants to trade large amounts while his broker offers Leverage 1:500.
This way, the trader can open a position equivalent to 5 lots.
In other words, 1000 USD*500 will be equal to the maximum 500,000 USD for a position.
In this way, a trader can place order 500 times the size of his deposit.
Thus, if Leverage 1:500 is used, the trade will be 500 USD instead of 1 USD. Of course, it is essential to say that a trader can lose these funds.
Now that we have understood the definition and analyzed a practical example of Leverage let's take a closer look at its application and find out what is the most optimal level of Leverage for forex trading.
What level of Leverage should I use?
It isn't straightforward to determine the optimal level to use, as it depends mainly on a trader's trading strategy and actual vision of forthcoming market movements.
A good rule is that the more you plan to keep your position open, the less Leverage you should use. It is quite logical, as long positions are usually opened when large market movements are expected. However, when you are looking for a long position, you want to avoid Stopped Out due to market fluctuations.
In contrast, when a trader opens a position that is expected to last for several minutes or even seconds, he usually tries to make the maximum profit within a limited time.
If we want to use Leverage, which one should we choose in this case? Usually, such a person wants to use high, and in some cases, perhaps the highest Leverage to provide the most significant benefit when trading on small market fluctuations.
From this, we can see that the forex leverage ratio is highly dependent on the strategy to be used. To give you a better idea, scalpers and traders who use a breakout strategy are trying to use the highest leverage ratio, as they usually prefer fast trades. Position traders often trade either without Leverage or with very low Leverage.
The desired Leverage for a position trader usually starts at 5:1 and goes up to 20:1. When scalping, traders tend to use Leverage, which begins at 50:1 and can rise to 500:1.
Knowing the optimal leverage ratio in Forex is vital for a successful trading strategy because you do not want to re-trade, but always want to get the most out of profitable trades. Usually, traders are advised to experiment with a strategy's Leverage for a while in order to find the most appropriate leverage ratio.
It isn't straightforward to determine the best level of Leverage to use, as it depends mainly on a trader's trading strategy and his actual vision of expected market movements. The general rule:
The longer you keep your position open, the less Leverage you should have.
It is logical - the longer a position is opened, the more market movement is expected. When a trader opens a position for a few minutes or even seconds, he mainly wants to maximize his profit within a limited time.
What is forex leverage - Which level of Leverage is the best in this case?
Usually, such a trader will seek to use high Leverage or, in some cases, maximum Leverage to provide the most significant benefit from trading with small market fluctuations.
It is usually advisable for a trader to experiment with different levels of Leverage to find the best ratio for his strategy.
How can I change my Leverage on Forex?
Once you start trading with a particular Forex broker, you may want to change your leverage level. It depends on the broker, and we cannot answer this question for every market participant.
Another essential aspect to keep in mind is that the Leverage is tied to the level of the deposit in your account, so sometimes when you invest additional funds in your account, the Leverage for currency trading can be reduced.
For example, a broker may provide 500:1 leverage for deposits below $1000 and 200:1 leverage for deposits between $1000 and $5000. After a trader has $950 in his account and opens a three lot EUR/USD position, he may decide to deposit a little more money to support the required margin, but after making a deposit, the leverage ratio may be changed, and the position will be closed when the Stop Out level is reached.
Leverage effect - Risks
It is important to note that forex trading using Leverage is a hazardous process, and your deposit will be quickly lost if you use high Leverage.
Try to avoid trading using Leverage, especially a high leverage ratio, at least until you have gained enough experience.
Summary - What is Forex Leverage?
We hope that this article has been useful for you and that you now have a clear understanding of what profits are, how to calculate Leverage on Forex and how it can be helpful and harmful to your trading strategy.