The word leverage automatically gives you a sense of being in an advantageous position, as it should, leverage means you have an aid in getting your goal done. While this point remains true in the world of finance, it should be known that leverage can be your greatest friend or your worst enemy.
When it comes to forex trading which is the exchange of one currency for another, leverage is one of the biggest selling points. It is the main attraction to the world of forex trading, because unlike stocks, bonds and options you can get a much higher leverage with forex.
Now, first we should clarify what leverage really means when talking about finance. Leverage is the process of borrowing a specific amount of money you need to invest in a certain trade. In the world of forex this is usually done through a broker. Leverage is used when trading on a margin. It is good to mention that leverage is used by investors and companies alike. Investors use leverage to considerably increase the returns that can come from their investment. Companies on the other hand use leverage to finance their assets, this helps prevent companies from issuing stock to raise capital for their businesses.
Leverage in Forex
As mentioned before you will not find leverage higher than what is offered in forex. So, to trade in the forex market, you will need to open a margin account with a forex broker. Depending on the broker and the size of the position, your leverage can vary from 50:1 to 200:1. Now what does this mean? When you have a leverage ratio of 100:1 you as the trader are responsible for having 1/100th or 1% of the total trade value in cash in your account. So, to trade $100,000 of currency with a margin of 1/100 you will need to have $1,000 in your margin account. If you were to trade in common equities you would see a leverage of 2:1 or 15:1 in the futures market. This is why it is so appealing to the traders to trade in forex, with the ability to trade at such a higher leverage, you can literally multiply your earnings significantly, and without requiring a large starting capital.
Double Edged Sword
Leveraged forex trading really is a great way to get into the game of trading, not only will you not need a lot of money, but you have the ability to make a lot of money. However, when it comes to leverage, there is one very important thing to remember, leverage can work against you as well. For example, if the currency value moves in the opposite direction of what you predicted and then your losses will be amplified immensely. The same way you stand to gain from leverage, you can also lose way more money than you have in your budget.
Don’t be completely discouraged, to avoid the apocalypse, there are different methods and trading styles you can use, such as, stop order and limit orders. These styles if used properly have the potential to greatly reduce your losses.
There you have it, make sure you do your due diligence and use leverage to your advantage. Forex gives you the floor to make large profits, seize this opportunity and make the best of it, through proper research and use of available information.
Sources:
Forexpros.se – One of the best forex sites in Sweden.