What is Leverage? Risks and benefits
Every Forex trader knows that leverage is an inevitable part of trading processes. Actually, it is one of the most important terms in Forex trading. It is what allows you to trade with a much smaller amount of capital than you would need otherwise.
How does it all happen? What is the meaning of leverage and what are its risks? In this article, we will try to give you the answers to these questions. Let’s begin with the basics.
What is leverage?
Let’s simply explain this: when you invest money to expand the profit, you can make more money using borrowed ones. In this case, the financial leverage can serve as borrowed money in order to get a higher return on your investment. You can use leverage to buy more assets or invest in more profitable ventures.
Leverage in the Forex market
In Forex trading, leverage is a very common concept. Traders borrow money from a broker in order to trade a larger position in a currency. Instead, a broker will want a percentage of the notional value of the trade to be held in your Forex account as cash, which is called the initial margin.
When the currency moves in the right direction, this can result in increased profits. However, leverage also magnifies losses, so it is important that traders know how to use it wisely and manage their risks.
Leverage is expressed as a ratio and it can be used to buy more currency units with the same amount of deposit.
You can choose a broker by comparing the leverage sizes they offer. This means that each broker offers different amounts of leverage, so you can find one that fits your needs. For US traders, check Forex brokers accepting US clients to know more.
What risks does leverage carry?
Although it is possible to make a lot of money with leverage, it can also work against investors. For example, if the currency you are trading goes in the opposite direction of what you thought would happen, leverage will make your losses a lot bigger. To avoid losing too much money, Forex traders usually have a strict trading style that includes using stop-loss orders to control potential losses. A stop-loss order is an order with your broker to sell a security when it reaches a certain price. This way, you can limit how much you lose on any one trade.
Conclusion
In short, leverage can be a very powerful tool when used correctly in the Forex market. But you need to remind yourself that with great power comes great risk. Before using leverage in your trading, make sure you understand all of the risks involved and are comfortable with them. If you're unsure about anything or would like some more advice on how to use leverage safely and effectively, speak to a broker or a trader who already had an experience with the leverage.
