Forex brokers allow investors to borrow money against an initial margin to trade with bigger positions which in turn might give you huge profits in cases of successful trades. For example, a 100:1 ratio means that you can control a $100,000 position with $1,000, which is the margin you will need to deposit with your broker in good faith. In easier words it means you get $100,000 to open a trade by depositing $1,000 which is your real investment. Now if you make a profit of $1,000 in that trade, your gain is 100% as your investment in real is also $1,000.
Risks involved with leverage
As much as leverage gives you power to trade, it can work against you with the same intensity. Leverage comes with the condition of huge potential loss as well if your trades do not go as planned. The same power you had can wipe your account in a single trade. If we look at the same example from above, if you lose $1,000 in that trade, your loss will be 100% which is an alarming percentage.
How to use it beneficially?
Here are some tips that can help you trade with leverage in a beneficial way without facing huge losses:
- First tip is for beginners, if you are new to forex then it is advised to practice trading without leverage at first. The reason for that is, when you are just beginning you will make a lot of mistakes, even if you practiced on a demo account, trading with a live account is a different experience. Avoiding losses in forex is inevitable, especially for beginners, you will have to learn to move past them and might take some time for you to start making profitable trades that overall are more than your losing trades. When you have achieved this level of expertise in forex then you can try using leverage to trade in bigger positions.
- The next tip is to keep the ratio of leverage low. Many forex brokers limit the amount of leverage for new investors, but in the end it is up to the investor how much leverage they want to use. Commonly forex brokers offer leverage in these ratios 20:1, 33:1, 50:1, 100:1, 200:1, and 400:1. However, as we discussed, higher leverage will amplify your potential losses as it does to your profits. So it is important to use only that leverage that you can afford according to your trading plan, risk management, and available capital.
- Our last tip is to use risk management techniques effectively. Make use of stop-loss and limit orders to minimize your losses and protect your trades in times of unfavorable conditions. There are many strategies and tools you can use to limit the losses you potentially might have to face in volatile market conditions.
It is important to trade smartly and treat forex as a business opportunity rather than as a shortcut to making huge money. We do realize high leverage gives a chance to make huge profits but if you want to keep trading with forex for a long period of time then you must consider all the risks involved and plan your trades accordingly and safely.