When we look into the current trend, we can easily find that many traders are getting attracted towards forex trading. Have you ever queried why it is happening? The mere reason behind it is the high leverage value offered in forex compared to that of other financial instruments such as stocks. Many of you have come across the word “forex leverage” in your trading routine, but few know its actual meaning, how it can influence your bottom line and how it works in day-to-day trading.
We can directly apply the usual concept of making use of other people’s capital to enter into a transaction in forex. Here in this article, we have presented the definition of forex leverage, how forex traders can make use of forex leverage and risk associated with it.
What is Forex leverage?
Leverage is similar to borrowing a specific amount of capital to invest it in something. In the case of the trading market or forex, this money is generally borrowed from a financial service provider, or we can say, broker. Forex trading offers high leverage value to traders.
Thus, it helps traders to own the large value share (which they perhaps cannot afford) by paying only a small percentage of the total amount.
For calculating the margin-based forex leverage, it is required to divide the net transaction value by the total amount of margin a trader is required to put up. The representation is as follow:
Margin-based forex leverage = Net transaction value/ total margin required
For calculating the real forex leverage value which you are using currently, just divide the total value of the transaction (for open positions) by the total trading capital.
Real forex leverage = Total face value of open positions/ Total trading capital
Why is leverage offered in Forex trading?
There are various reasons why financial service providers offer forex leverage. Every capital market generally provides it, but leverage in forex is usually much higher in comparison to other trading instruments. For the US equity market, the leverage offered is about 1.5 times the total value of the share.
Forex leverage is as high as 500:1 for professional accounts. The financial service providers are comfortable providing this level of leverage due to several reasons.
- Forex is comparatively less volatile: The net volatility on the prominent forex pairs is approximately 10%. When comparing it with the stock market there the percentage of volatility is about 40%.
- Forex market remains open for the entire day: One can trade 24 hours a day and six days a week. Many other financial markets open only during exchange hours.
- The liquidity of forex markets are high: A trader can exit and enter with very low slippage. The broker can easily exit if it has to liquidate the trader’s position.
T1markets provides excellent leverage up to 1:500. If you are the one looking forward to investing in forex, then you can definitely go with this firm, a leading name in the financial world. It is a well-regulated firm providing trading on affordable rates that is $250.
Trade size and Forex leverage
A financial service provider has a different margin requirement for smaller traders and larger traders. If the leverage value which broker is offering on trade is 200:1, it reflects that the investor is expected to have at least 2% of the total trade value in its trading account as collateral. For standard trading, the currency units considered are 100,00 units. Thus, for the trade of this particular size, the offered leverage might be 100:1 or 50:1. Higher leverage value or ratio of 1:200 is generally employed for the trading positions of $50,000 or less than this.
Many financial service providers allow traders to carry out the smaller traders between $10,000 and $50,000 in which they might provide the lower margin. However, for a new trading account, of course, they won’t allow the 200:1 leverage.
Forex brokers are required to manage the trading risk, and while doing so, they might surge the margin requirements of the trader or may decrease the ratio of leverage and finally, the size of the position. The leverage provided in the equity market is about 2:1, and that provided in the futures market is 15:1. So, you noticed the difference between the forex and other market leverage.
Advantages of trading Forex with high leverage
1) Allow the trader an opportunity to invest with the low capital in the market
There was a time when wealthy people dominated the market. They were the one who used to invest large capitals in the financial market and harvest huge returns on investment. With the forex leverage, things changed. The trader having low capital can also harvest most out of the market. Just the need is choosing the right broker to start. T1markets provide excellent leverage along with a simple account opening process.
2) Leverage is exempted from interest
You get the leverage from a forex broker despite this fact the capital does not incur any interest. If you wish to begin trading, you can receive the loan without any fear of interest payments.
3) Bigger profits
If you are the one wishing to surge your profit, then you should definitely trade with leverage. Suppose if you have just 100 dollars in your account. You can still trade on the trades up to 100,000 dollars with the leverages. Trading with the larger amount will automatically surge the chances of profit. So, in short, the profitability of a trader is enhanced through leverage.
Disadvantages of trading Forex with high lever
1) Heavier losses
Working on leverages or with a forex financial service provider surges your chances of harvesting the higher returns, but it also opens the way for massive losses. Big gains can turn into the smaller ones. Likewise, small losses can turn into the bigger ones. Thus, trading in the foreign exchange market requires attentiveness and carefulness. Also, always remember to press stop on the trade whose prices shift far away from your trading forecast.
2) Leverage is a fixed liability
Leveraging creates an urgent liability which requires to be fulfilled by the end of the trading day. The primary value of leverage needs it to be fulfilled no matter the extra amounts you have to give or the online transaction went down or up. The amount of leverage has to be paid for a trader to continue trading.
3) Margin Call Risk
It is the biggest risk which is always present in trading. The trader might fall under the requirements of margin set by the financial service provider. It is the size of a transaction which a trader needs to meet depending on its capital. In case, you fall below the threshold level; then the brokerage firm may push a margin call which will automatically liquidate the portfolio of the trader. It means that all the trading positions which might have delivered tremendous returns are closed early. This ever-present risk on the current leverage is something a trader should be aware of while managing the capital for avoiding such things.
The risk associated with leverage trading
The risk is inevitable while trading. It can arise due to small price shifts in the market. One cannot avoid, but it can definitely mitigate its level.
- A trader is usually exposed to the financial market risk, especially when he is not aware that his trading position has shifted or not at the time when he is not monitoring the market.
- The trader is also exposed to the risk of the interest rate. If the rates of interest rise the amount of borrowing the money will also surge.
- The trader may also be subject to various political risks, which might influence the value of the trading position and thus make it impossible for the trader to exit the position.
Leverage risk management
Apart from the leverage and trading platform, the forex broker also offers some risk management instruments such as stop-loss orders which can help investors to handle risk more effectively.
Some of the basic points which can mitigate the risk due to leverage are:
1) Keeping small trading positions
2) Making use of trailing stops
3) Try to limit the amount of money for every trading position
So, from the article, it is clear that forex leverage can be employed profitably and successfully with proper management. Always remember that the forex leverage is customisable and flexible to each investor’s choices and needs.
The Bottom Line
Trading in the foreign exchange market is common, as it allows a trader to make more gains and also generates strong returns with a handful of funds in an account. Many traders get drawn to the forex market, as here the requirements of margin are lower compared to the value of money a trader can control.
However, “forex leverage is a double-edged sword”. However, employing leverage can generate huge profit, it goes without saying, but on the flip side, it may lead to massive losses too.
There are several risks associated with leverage which we mentioned in the article. Along with the risk, we have presented various ways to mitigate it. So, read them properly and try to employ them in your trading.
Select your broker wisely. Never risk your hard-earned money with any fake brokerage firm. T1markets is a well-regulated authentic broker working under the guidelines of Cyprus Securities and Exchange Commission. Follow the reviews of T1markets on the website www.fxreviewtrading.com