Leverage is the ability to make large trades in the foreign exchange market by investing only small amount of money in your forex trading account.
Forex trade by using leverage is known as margin trading which allows trading with borrowed funds. Leverage is helpful in increasing the financial capabilities of a trader. Brokers provide leverage free of charge on a permanent basis. Forex brokers provide leverage to make the currency market accessible for the average investors. Usually the traders need $10, 000 to start Forex trading. If your broker provides a leverage of 200:1 ($200 for every $1) you can start trading by depositing $50 in your trading account because it will control a trade of $10,000.
Leverage in currency trading acts as a sharp double edged sword because either it works for you or against you. For example if you trade with a mini lot of $10, 000, each pip would be approximately $1. Suppose you gain five pips, it means that you have made a profit of 10% by investing only $50 but if the trade goes against you and you lose five pips, means you lost 10% of you capital in no time. You feel happy by thinking about the money that you can make by using leverage but the money that can be lost is rarely discussed. Currency exchange brokers offer heavy leverage, but it does not mean that you are compelled to use it every time. Leverage is very dangerous if not used properly.
Did you know that excess leverage can kill your trading capital?
While choosing a Forex trading broker, you will notice that there are many brokers who offer extreme leverage. Some of them even offer you 400:1 leverage. This will allow you to open a trading account with $300 and you can control trade worth up to $120, 000. The average pip size in this case is $12. Suppose if you lose 25 pips in your trade; your entire capital of trading account would be wiped out. Usually most of the currency pairs can move 25 pips in short duration of ten second, means your trading account can be wiped out only within 10 seconds
Leverage can be helpful if you use it as an online trading tool. Generally the dangers of using extreme leverage are rarely discussed, but you should think about it. There are many ways to use leverage in useful ways to draw maximum advantage from it. The best time to use leverage in currency trading is when you are making profitable trades. If the trade is progressing in your favor and you want to add it, this is the best time and good use of leverage and is known as leveraging your profits.
Although leverage is useful for the Forex traders but it also works against the trader. If currency rates move against your predictions, the leverage will increase your potential loss. Therefore always choose the leverage that is suitable for your trading strategy and always test it on a demo account several times before using them on real account. In short, leverage is a very useful tool in the Forex trading if used properly.
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