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Table of contents
- What is Leverage?
- WHY LEVERAGE TRADING?
- How Does Leverage Work in Forex Trading? - A Detailed Explanation
- Forex Margin and Leverage
You've probably heard about Margin Call. Many traders are scared breathless of these two words. But in fact, this function is designed to protect your deposit. Unfortunately, it often happens that novice traders misjudge their risks. When it becomes obvious to the broker that the chance of you losing your deposit is high, they call or send you an auto-message about the need to replenish your balance to cover high risks. Sometimes negligent traders forget about leverage and the obligations associated with it.
What is Leverage?
As a result of unreasonable trading, they can turn into the debtors of the company. To avoid this, use the services of brokers that guarantee zero balance in case of liquidation of trade. Thanks to this feature, you will never lose more than what you have on your balance.
However, there is a dark side to leverage. Beginners should pay close attention to the disadvantages of forex leverage. This risk is a psychological trap that a trader falls into when using a high leverage. There is a feeling you have a lot of free money that you need to use and invest in something.
It is very important for every beginner to remember that leverage not only gives additional opportunities but also creates obligations. The most important one is to cover losses at the expense of your own funds in order to prevent Stop Out you can find a detailed description with examples here. Since with the large leverage you can open positions hundreds of times larger than your real funds, there is a risk of incurring enormous losses to your balance. This situation is especially dangerous when several large positions are open at once. If you get losses in one trade, your account level decreases for all other open positions and the risk of Stop Out in these trades increases.
WHY LEVERAGE TRADING?
In other words, if you abuse a free margin, your large structure of positions can collapse in a moment like a house of cards and burn up your deposit. As mentioned above, it is very easy to incur a big loss on your balance with a large leverage. Newbies naively believe that since the leverage is large, it is quite easy to get the account back to its previous size. But you should always remember that to compensate for losses, profitability must be many times higher. Below is a table for calculating the percentage of profit to return to the breakeven point in case of losses.
I recommend printing it out and placing it in front of the working screen as a reminder to follow risk management rules.
- What Is Leverage in Forex Trading?.
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In the case of large leverage, with losses on the balance your purchasing power falls as well, available funds for collateral decrease, and therefore the risk of Stop Out increases. This is usually compensated for by a decrease in the volume of positions, which in turn reduces the potential profitability, i. It is important to always remember that using low, medium or maximum leverage on Forex is a commitment.
You return the main value of the leverage in the form of swap regardless of whether you succeed or fail at the end of the trading day. The leverage cost must be covered by the trader's account and will be automatically deducted from their balance. Obviously, the cost of leverage directly depends on the volume of its use.
The broker usually charges the commission only for the actual amount of funds used. If you are new to Forex, the ideal start would be to use leverage and 10, USD balance. So, the best leverage for a beginner is definitely not higher than the ratio from 1 to How do you find the best leverage in Forex for you? Obviously, the answer to this question will be different for each trader.
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- What is the Best Leverage in Forex.
The table below shows the calculation of the required collateral and deposit change for leverages with a classic lot of , USD. Now we will calculate the maximum size of positions that we can open and the risk per trade, subject to the above rules. In the table above, we see that with such risk management requirements, the optimal leverage on Forex is , since in this case we will be able to open positions at once that meet our risk management rule, or several positions with a minimum risk.
From this example, it is obvious that for trading with a lower leverage, you need to increase your deposit so that you can actively trade with the required level of diversification. You may say that this is a contradiction. How does trading with a large leverage reduce risks? In fact, there is no contradiction. Liquidation risks do go down with higher leverage, provided that trading volumes remain the same. All the disadvantages high leverage I told of above relate to the psychology of a trader and violation of money management rules , which is why it is so important to work on your trading strategy and discipline in trading.
Then the high leverage will not be a problem and will not lead to losing the deposit. From the examples above we concluded that high leverage is okay. If you follow the rules of risk management and have proper trading discipline, high leverage is more of an advantage. There is simply no liquidity provider on the foreign exchange market that would cover leverage of more than So any Forex broker with leverage like , should immediately raise suspicion.
Another sign of an unreliable broker is that you cannot trade directly with a liquidity provider using a raw market spread.
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- Low Leverage Allows New Forex Traders To Survive.
Pay attention to customer service as well. Brokers who take care of their clients have a service that works around the clock and answers any requests quickly. Such brokers also provide a personal manager service for large clients and a wide tariff range for each client. If you analyze the broker market, you will surely notice Liteforex. It has many advantages over other brokers:.
Using leverage, one can drastically reduce the amount of capital required. Considering that you entered with a full lot, the price has to go only points in 5-digit representation from the point of entry in the "wrong" direction for your trade to be closed by Stop Out. As you understand, this is a colossal risk. As we have seen, the best leverage ratio on Forex is a relative term. In addition, this tool must be used with care.
Using too high a leverage can either bring incredible profits or ruin the trader. The best leverage for Forex trading depends on the capital at the trader's disposal. It is believed that a ratio of to is the best leverage for Forex. In this case, a trader can get tangible benefits from margin trading, provided correct risk management.
At the same time, it is vitally important to follow your own risk management rules, not to abuse free margin and always keep a reserve of funds for potential closing of all open positions by stop loss in order to avoid early liquidation of active trades.
How Does Leverage Work in Forex Trading? - A Detailed Explanation
Best leverage in forex trading depends on the capital owned by the trader. It is agreed that to is the best forex leverage ratio. So leverage is the best leverage to be used in forex trading. Leverage is solely a trader's choice. Most professional traders use the ratio as a balance between trading risk and buying power. If you are a novice trader and are just starting to trade on the exchange, try using a low leverage first or While doing so, always remember about the risk management system.
Follow its rules! The average starting balance for a Forex trader is higher. Open more than one position with caution. He is trading with leverage. The currency pairs that he normally trades move anywhere from 70 to pips on a daily basis. In order to protect himself, he uses tight 30 pip stops. Bill feels that 30 pips are reasonable but he underestimates how volatile the market is and finds himself being stopped out frequently.
Forex Margin and Leverage
After being stopped out four times, Bill has had enough. He decides to give himself a little more room, handle the swings, and increases his stop to pips. His leverage is now over He decides to tighten his stops to 50 pips. He tries again with two lots. This time the market goes up 10 pips. He opens another position with two lots. The market drops 50 points and he gets out. The market moves pips pretty darn easy. Are you starting to see why leverage is the top killer of forex traders?