Leverage is a crucial factor in the forex market that many traders ignore and regret ignoring. To define leverage, we can say that it is a widely used strategy in money management and investment that allows a trader to borrow money for elevating their returns on investment. In this technique, a trader opts for taking debt instead of utilizing the capital for investing or purchasing any financial security or asset. He does this with the anticipation that he will earn enough profit to pay off the debt and still leave him in a profitable financial position. In simple words, leverage can lever the balance of your account.
Usually, traders conduct trading in forex through some best broker for forex trading. You can get a loan or leverage from a forex broker to leverage your investments in the market in the forex market. With the help of this loan, you can conduct large volume transactions despite actually holding a smaller amount of capital, summing it up as money borrowed to trade significant positions. As the leverage has a multiplier effect on a trader’s profits, it can also act in a reverse manner by blowing it up with losses. It is important to handle leverage intelligently to earn the maximum benefit from it besides saving yourself from the risk of the potential loss. This can be achieved by employing the best money management strategies while dealing with leverage.
Leverage offered by brokers:
The leverage offered by forex brokers usually forms a trend, as shown below.
1:2000 and others.
A 1:100 leverage means that for entering a trade of $100000, only $1000 will be deducted from your account by the broker. 1:1 leverage represents that the trader needs an equal amount of money to hold a position.
Effect of leverage on margin:
The margin represents the limit set by the broker as a protective shield to help you not lose more money than the amount you have invested. In case of making a wrong decision and investment, the leverage will cause your account to start to be drained out as the volume of investment had been multiplied through the leverage. Once your account balance reaches a certain level, the broker will ask you to inject more funds through a margin call.
It is on your disposable that you decide to inject more funds into your account or not. If you are not willing to add more money to your account, you can simply bear the loss and manually close the order. If you do not do so, the preset margin will let the software stop the trade automatically when you reach your limit in the form of margin. Managing the leverage with the margin level can prove to be a challenging task for the traders and especially for beginners. Some traders prefer high leverage and low margin for trading with a small trading budget.
On the other hand are some traders who do not support this idea. They base their argument on several supporting arguments. It is the trader’s job to analyze it and decide what can really work better for him.
Determination of leverage for trading:
The most crucial part comes here when the trader has to determine the leverage for himself that is the most suitable and profitable for him. Especially beginner forex traders come across this challenge and do not know what to do. To cope with this situation, you can use strategies used by experienced and professional traders to choose the best leverage for themselves. One of these strategies is known as the 3K’s rule that can really help you out. The rule goes as follows;
- Keep the leverage to the lowest level possible
- Doing break-even analysis for your trades
- Your position per trade at a level around less than one or two percent.
The most crucial factor to keep in consideration is that the level of leverage. It heavily depends on your trading practices and styles. Analyze your trading style by choosing one among many trading styles, including day trading, swing trading, position trading, short time trading, scalping, etc. Classify yourself on the basis of your approach, such as aggressive or conservative. However, for beginners, leverage around 1:10 and 1:50 is suggested by the traders. Beginners must be conservative in their approach towards risk and therefore not choose leverage above the suggested levels. The market study represents that beginner trader who keep their leverage level low has more probability of surviving in forex. Which is gigantic in trading volumes and highly volatile.
The second K suggests traders use break-even analysis every time they conduct a trade. Another important point is placing stop-loss as a mandatory obligation. The main challenge facing traders in the forex market is minimizing the risk of potential loss while collecting profits. The forex market volatility is an open secret for everyone. There always remains the risk of uncertain movement of the forex market. Placing stop-loss helps you in dealing with this volatility by protecting your account and capital. It is crucial to saving your capital for future trades so that you have the choice and ability to enter. Without capital, you cannot enter trades and eventually cannot expect to earn profit.
In the same manner, using break-even analysis is a must in forex trading. After calculating break-even, you can then utilize it by moving it in accordance with the direction of the market. This strategy helps you to save some of your profits by locking them in. It provides you with a psychological edge by making you risk-free. This will eventually help you to trade in some other currency pair in a new trade with ease. But this must involve adequate break-even analysis. Be aware of mixing your emotions in the analysis. This can cause you a great deal of trouble and inconvenience. It is better to follow the market and its trends instead of following your emotions.