How Leverage Trading Works in the Forex Market
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Leverage trading, also known as trading on margin, is a widely-used practice that allows you to trade without paying the full amount of the position. It is available for all asset classes and it is one of the most efficient ways to use your capital while aiming for the goals profits. Let’s discuss more about it below and see how easy it is to use it!
What is Leverage Trading?
In trading, leverage is basically a loan you get from your broker when you don’t have enough funds to open a position on the desired asset. Let’s say you’re a big Apple Inc. fan, the stock is booming and you have enough knowledge to invest in it. You’re 100% ready to proceed but you don’t have enough capital in the account to buy $10,000 worth of stock. Leverage makes it possible to invest only around $3,000, adding the rest of the cash for you. While leverage is applicable to all asset classes, such as stocks or commodities; it is primarily used to trade forex.
Since leverage trading works as a loan, this means you are ought to pay it back at some point, with interest. This makes it carry a high degree of risk, given the fact that there’s always the possibility for the trade to go unplanned. Moreover, an overwhelming number of brokers use this feature to scam traders. To avoid this scenario, check all the legal documentation of the broker you plan to work with. You can choose a broker like TradeFW.com, which is regulated and authorized to operate by the Cyprus Securities and Exchange Commission (CySEC), the independent public supervisory authority responsible for the supervision of the investment services market and transactions in transferable securities carried out in the Republic of Cyprus. It is also fully transparent about its leverage options (up to 1:30), as well as legal matters. A great example of how a legit online investment firm should look like!
How to trade with leverage in an efficient way
Leverage is the best tool to maximize your trading potential. To use it, all you need to do is open an account with a licensed online broker that offers you this service; and opt for the leverage ratio you want. In order to use it efficiently, it’s important to choose the suitable leverage ratio according to the asset you want. The amount of leverage provided can have some of the following ratios: 50:1, 100:1, 200:1, or even 1:400. For instance, at a 1:400 leverage ratio – with $1,000 in your account, you have the ability to control $400,000! These ratios typically depend on the broker you’re trading with, the jurisdiction of your location, as well as on the total volume of the open positions.
Check the level of the following elements of your account:
- Balance – shows the size of your trading account.
- Equity – shows the value of the account.
- Margin – shows the blocked collateral.
- Free margin – shows the available amount.
- Margin level – defines the risk (a lower level is preferred).
By understanding how leverage works, you’ve already minimized the risk. Find out the leverage ratio that fits your trading style and design a proper money management plan to help you use leverage in a responsible way.
The advantages and disadvantages of Leverage Trading
The main advantage of leverage trading is the possibility to substantially increase the returns you obtain on an investment. It allows you to trade at a professional level with minimal capital exposure. The appeal should be clear by now, right? With the right leverage ratio, a good strategy and a solid risk management plan, both beginner and experienced traders can savor the dreamed profits.
On the other hand, if you’re not conscious of the severity of the risks posed by leverage and how easily it can backfire, it can turn into one of your most regrettable experiences. Just as leverage can move strongly in your favor, it can equally move against you when you call a position incorrectly. This is arguably the biggest disadvantage. In some cases, in order to ensure customer protection, certain financial authorities even limit the leverage. For example, in the United States, a 1:50 ratio is the norm.
Leverage trading is a common practice suitable for all asset types, but it is heavily-used in forex tradingheavily-used in forex trading. While it holds the ability to bring you the rewards you’ve been dreaming of, whilst allowing you to manage a capital that exceeds your initial deposit; it can also work against you. To minimize the risks of using this tool, pick a solid trading strategy, the appropriate leverage ratio and create a trading plan to follow that encompasses risk management techniques. When done right, leverage trading can be the key to your financial success!