Forex leverage, or trading with borrowed money, is one of the main attractions of the forex market. In forex trading, you get much higher leverage than in stock trading. With leverage, you only need an initial margin or a small capital in your account to open large positions. The forex leverage of 100:1 is common in the foreign exchange market, which means that you can trade a value of $100 for every $1 in your account. In other words, with a leverage ratio of 1:100, you can trade 100 times the value in your account.
The forex leverage is a highly valuable tool for beginner traders as they can use it to their advantage and greatly increase their profit provided, they use it intelligently. In this article, we will discuss why forex leverage is highly valuable for beginners and how beginner forex traders can use leverage to their advantage.
How Does Leverage Work in Forex Trading?
The first step in understanding forex leverage is to understand margin and maintenance. Forex margin refers to the amount of money you have to deposit as collateral with your broker. If the market moves against your position and your account dips below a certain value, your broker will not force you to liquidate positions to cover your losses. In contrast, maintenance refers to a minimum balance that must be maintained in your account at all times. In the event that this dips below a certain point, a margin call will be triggered.
Forex margin loans allow traders to borrow money from their broker to purchase more assets than they could otherwise afford. Simply put, leverage is borrowing money in order to trade.
For example, with 1:2 leverage, you would open a $1000 forex account and have $1000 in it, plus another $1000 lent by your broker. In this case, every 1% movement in the market will result in a 2% profit or loss. With 5:1, if you make a riskier bet and it goes up 5%, you'll win 10%, and if it goes down 5%, you'll lose 10%.
What is the best leverage for a beginner forex trader?
Forex beginners should choose leverage based on their comfort level. A lower level of leverage, such as 5:1 or 10:1, might be more appropriate if you are conservative and don’t like taking many risks.
A beginner forex trader should also consider placing stop loss and take profit orders as it is the most reliable method for reducing losses. The use of limit stops allows traders to continue learning how to trade currencies while limiting potential losses. Additionally, these stops help reduce the emotional aspect of trading and allow beginners the freedom to leave their trading desks guilt-free.
Traders with low leverage are more likely to survive!
You should understand both the benefits and pitfalls of trading with leverage as a trader. As an example, a ratio of 100:1 means that for every $1 in your account, you can place a trade worth $100. You can trade up to $100,000 at 100:1 leverage with as little as $1,000 of margin available in your account. This means that you can earn profits on the equivalent of $100,000 of trades.
This is like a skinny guy going into an arm-wrestling competition with a long forearm. Due to the leverage that his forearm can generate, if a trader knows what he's doing, he usually wins even if his opponent is Arnold Schwarzenegger. Your gains are magnified substantially when leverage is used effectively. Your head gets BIG, and you think you’re the greatest trader that has ever lived.
However, forex leverage might also work against you.!
In the event that your trade moves in the opposite direction, leverage will greatly increase your potential losses. You’ll be bankrupt before Mike Tyson can reach your ear. It goes without saying that the more forex leverage you use, the smaller the “breathing room” you have if the market moves in your favor before a margin call occurs.
How can beginner forex traders use leverage to their advantage?
Leverage is a double-edged sword, which means that a high-leveraged trade can quickly deplete your trading account should a trade go terribly wrong. Leverage amplifies your gains as well as losses, so you should be careful while using leverage in order to gain an advantage. Beginner traders should use the following strategies while using leverage to gain the maximum advantage of the leverage.
1- Limit your losses
When using forex leverage, you must limit your losses and ensure that your winners are greater than the losing trades. One big loss can eliminate a series of gains, so managing your trade and keeping it within the tolerable loss limits is critical to your success as a trader.
2- Set stop-loss
While using leverage, you must set a stop-loss on each of your trades so that you don’t lose more than a certain percentage of your account on a single trade. Stop-loss ensures that you are not carried away by your emotions during trade as leverage would significantly magnify the outcome of the trade and you would be emotionally attached to the trade. A stop-loss point would ensure that you are taken out of the trade the moment it moves against you, limiting your losses and securing your trading account.
3- Use appropriate leverage level
Your forex broker might offer you higher leverage such as 1:100, but you don’t necessarily have to avail the maximum leverage limit. You should avail the appropriate level of leverage that suits your risk-return objective and your trading strategy. When the market is highly volatile, you should keep your leverage level at a minimum and vice versa.
4- Use appropriate trade size
When you use high forex leverage, your trade size can be too big to handle comfortably, and you might even risk losing your account as a small change in the market can have a significant impact on your trading account. To effectively manage your trade, you should choose the appropriate trade size along with the appropriate leverage level so that you are able to manage your trade comfortably.
Forex leverage, when used appropriately, can do wonders for beginners. Beginner traders can enter forex trading with little capital and use leverage to execute their trades. However, leverage can quickly devour new traders’ accounts if they are not careful about using leverage. By following the strategies, we mentioned above, beginner traders can improve their trading and use forex leverage to their advantage.
Pros of Forex leverage for beginners:
- As mentioned earlier, beginner forex traders who don’t have large capital can use forex leverage to make large trades. Traders only have to deposit an initial margin, a small percentage of total trade value, to initiate a trade.
- The forex leverage allows you to trade using borrowed money from a broker. However, you don’t have to pay interest charges on leverage, which makes using leverage a profitable and inexpensive proposition.
- Because you can make large trades with the forex leverage or borrowed money, you have the potential to significantly magnify your gains in case you make a profitable trade. The magnified returns are not possible if you only use your own money in your trading account.
Drawbacks of using Forex leverage:
- The Deposit Can Never Be Recovered: Once you have lost all your money, the deposit is non-recoverable.
- Losses Are Magnified: While leverage can improve your returns, it can also magnify your losses if you choose incorrectly. You can lose your entire deposit with some leverage. Therefore, it is important for beginner forex traders to research the best leverage based on their risk tolerance.
Read How beginner forex traders can use leverage to their advantage for more information.
Forex Leverage Vs. Forex Lot Size
Trading forex successfully requires a solid understanding of forex leverage and lot size. It is possible for new forex traders to get confused by the terms because the two have a connection. Here are some differences between them that will help you distinguish between them;
Definition: The lot size refers to the number of currency units bought or sold per transaction. Whereas, forex leverage represents how much you lend to your broker against what you own.
Representation: The size of a Forex lot is usually expressed as currency units, for example 100,000 or 1000. By contrast, leverage is expressed in terms of ratios, such as 10:1 or 1000:1.
Limit: Standard lots in forex trading are 100,000 units, which is the maximum lot size. In order to trade, a Nano lot is required, which equates to 100 units. In terms of forex leverage, the maximum is 1:5000, while the minimum is 1:1. However, this largely depends on the forex broker you choose.
Why is a Forex Trading Course Necessary for Successful Trading?
The forex trading course is designed to provide newbie traders with a better understanding of the forex market and the fundamentals of trading so that they can enjoy greater success in the market and gain greater profits. Traders learn about forex quotes, trends, analysis and chart patterns that are essential for developing a successful trading strategy. For those who wish to have a successful trading journey, a forex trading course is a must.
AximTrade provides a multiscale comprehensive online forex course conducted by professional forex traders that helps anyone gain an understanding of the forex market. The content of the course was developed based on the experiences and knowledge of successful traders. There are three levels of the course ranging from basic levels to advanced levels, which provide a wide range of trading techniques. The course is entirely free, and the learning curriculum is accessible for life.