Forex trading is buying and selling currencies in an attempt to turn a profit. It’s the largest market with the most liquidity, and it sees more than $5 trillion in trades daily. There is a lot of money to be made through forex trading, especially when leverage is used correctly. However, as with all things investment, there’s enormous risk and a lot of traders lose money. Below, we’ll find the pros and cons of leveraged trades and find out whether it’s right for you.
Pros of Trading Forex with Leverage
Leverage offers traders much more flexibility because they can take on more (or less) risks, which leads to high returns or a steady flow of low returns. For example, if you use a low leverage ratio, you can afford to make more trades and you’ll see a higher win rate, even if individual profits are much smaller. On the other hand, if you’re using a high leverage ratio, you’ll be investing in trades with high potential.
When forex traders are short on liquidity, they can use leverage to control larger positions without having the money upfront. For the most part, this is only useful when capital is low. For example, a leverage ratio of 100:1 allows you to open a position with $100,000, and you only need to deposit $1,000.
Forex traders can boost their profits by taking on leverage, which allows them to make more money than they usually would while paying the same price. For example, if you have a leverage ratio of 100:1, it only takes a 1% movement in the price for the pair to gain or lose 100%.
Even though leverage trading can be profitable, it can also come with a series of disadvantages. For example, the depreciation of a leveraged position can lead to the risk of ruin, which is the loss of all available trading capital. This is because even the smallest losses are amplified.
If the market moves against you, then you can end up losing more money than you invested. For instance, if you open a position with a 100:1 leverage ratio and the market takes a downward turn by 1%, you’ll have lost 100% of your initial investment.
If your balance falls below a specific threshold, you will receive a margin call. Essentially, this means you have to deposit more money or liquidate trading positions to avoid being stopped. If you don’t have the capital to deposit and the market is heading downward, this is a serious problem.
Leverage can be a valuable tool for forex traders, but it’s a double-edged sword that can lead to overwhelming losses. Before you consider experimenting with leverage, you need to be confident in your abilities. Typically, only experienced traders with plenty of capital and risk tolerance use leverage, but they only use it when they need to increase returns or control higher positions.
If you’re new to trading forex, you’ll have a mountain of learning material to get through and then you have to practice your trading strategies on a demo account from a reputable platform like easyMarkets. Further, if you’ve been known to allow emotions to seep into your trading strategies or you’ve had to borrow money to get leverage, you should leave it well alone.
Once you’ve got a thorough grasp on the inner workings of forex trading and you’ve had a chance to practice your skills, then perhaps you’re ready to take on some leverage. However, you’ll need to know how to manage risk. The following tips will help you decrease your losses while using leverage:
- Use stop-loss orders. Stop-loss orders are automated tools that traders use to withdraw from a position once a predefined loss threshold has been reached.
- Limit risk per trade. 1-2% of your entire trading balance is a good starting point per leveraged trade.
- Use low leverage ratios. Until you become more experienced with leverage, we recommend using a 10:1 or 20:1 leverage ratio.
- Monitor trades closely. Keep tabs on the market value when you have leveraged trades, and check that stop-loss orders are set properly and working.
- Take profits early. As soon as you’ve reached 2-3x your initial investment, withdraw from the position. Even though the value could go higher, there’s every chance it will plummet.
- Diversify your portfolio. Never put all of your eggs in one basket. Trade different currency pairs and explore different strategies to reduce your overall risk.
Leverage is a powerful tool that can generate enormous profits for forex traders, but it’s important to tread carefully and understand how to use leverage responsibly. All it takes is one poor decision and you can end up suffering a significant loss.