What is Leverage in Forex?
The more advantage you can gain in business, the better for you. Whether you are an investor, trader or entrepreneur, being able to raise higher capital determines the extent of returns you get. Therefore, if you could borrow to increase your stakes in any investment to maximize your profit, you are utilizing leverage. However, most beginner traders use leverage to the detriment of their forex trading account.
This article will cover everything you need to know about forex leverage and the safest way to use it in forex trading.
What is Leverage?
When you use borrowed money as capital or investment with the expectation to make greater profits than the interest you should pay, you have engaged the financial concept of leverage. Businesses utilize leverage to expand their firm’s assets and generate quick returns on risk capital and investment (ROI).
Understanding financial leverage and how it works
When you describe a firm or establishment as having high leverage, the firm has more debt than equity. It is the strategy of using borrowed funds as capital to run a business with hopes of generating higher profit to clear the debt and have more to carry on. However, the tricky part of leverage in business is that, while it has the potential to boost returns on investment, it can also impoverish an establishment.
Leverage provides an alternative means for businesses to raise capital without issuing stocks. Also, it works like a lever to amplify ROIs (return in investments) in virtually all sorts of companies.
Examples of areas where you can employ leverage include but are not limited to:
- General business
- Professional trading
- Financing projects (public or private), etc.
Leverage works by bolstering the purchasing power of business owners to expand their business opportunities. Essentially, borrowed funds are not the only ingredients for business expansion.
One can combine equity or personal funds, perhaps from savings, with borrowed funds to execute a project. Interestingly, the total funds you generate from combining debt with equity will be greater than your equity alone—showing the essence of leverage.
However, you should use leverage with the utmost discretion as it can quickly ruin your business expansion dreams if not appropriately managed.
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What is leverage in Forex trading, and how does it work?
Leverage in forex trading is not so different from financial leverage, except that the subject for leverage is the trader and their forex trading account. Essentially, leverage in forex trading is an avenue for a trader to trade higher volumes than usually possible based on available trading capital.
A trader can use small trading capital to control high trading funds to generate huge profits in the foreign exchange market. In simpler terms, it uses a small account to control larger trading volumes to create more profit by increasing your staking volume in the market. Using leverage in forex trading is a double-edged sword. While it has the potential to increase your earnings exponentially, it can drastically magnify your losses if something goes wrong.
However, your profits or losses using leverage to trade depend on your risk management and calculation. It is advisable to focus on mitigating your losses rather than increasing your earnings to keep operating forex leverage safe.
When engaging forex leverage to navigate the foreign exchange international market, your broker determines the amount of leverage you use. However, you still reserve considerable trading rights to increase your leverage to 400 times your trading capital.
So, essentially, leverage gives the trader more flexibility and excitement in trading. Interestingly, your trading excitement is short-lived, especially when you have real money on the line. Some inexperienced and even professional traders sometimes use demo accounts, especially when trying out a new leverage volume.
Fun Fact: The more leverage you use, the higher your risk of losing your capital and blowing your account. As a result, professional traders trade with leverage of about 10:1 or 20:1.
Leverage amount, and what is the best Leverage in forex?
Your forex leverage amount is the number of funds your broker is willing to lend you for trading the currency market. It is usually based on the investment of your trading capital and offered by a good number of brokers.
For instance, eToro offers reasonable trading leverage that benefits newbie traders. You can open an eToro forex trading account to access the excellent trading services and utilize the forex leverage at a reasonable cost.
Different brokers offer different amounts for leverage. As a result, every broker sets their offer rate depending on their internal policies. Generally, forex leverage is provided and expressed in a ratio.
For example, if a broker gives you a leverage ratio of 1:100, it means that for every $1 equity, you can open trading positions for as much as $100. Therefore, the million-dollar question becomes, “what is the best leverage ratio for beginners?
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Types of forex leverage Amount
No two brokers have the same rule for providing forex leverage. So, they give a fixed amount that varies from broker to broker. Essentially, they are commonly four categories of leverage amount.
Here is a brief explanation and how they work!
50:1 (Fifty-to-one leverage)
The 50:1 leverage means that for every $1 equity you have, you can place a trade that is worth $50. For instance, if you deposit $100 and operate a 50:1 leverage amount, you can profit $5000 in the currency exchange market. ($100X50)= $5000
100:1 (One-hundred-to-one leverage)
100:1 leverage amount means that you can trade up to $100 for every $1 equity. The 100:1 is the typical forex leverage amount for most traders (novice and professional) for a standard lot. It means that if you made a minimum deposit of $1000, you get the ability to control a $100000 account.
200:1 (Two-hundred-to-one leverage)
The 200:1 leverage amount is the typical offer for a mini lot account. For every $1, you make a trade worth $200, and the standard minimum deposit for such an account is no more than $300, enabling you to trade up to $60000.
400:1 (Four-hundred-to-one leverage)
Although some brokers offer the 400:1 leverage amount on a mini lot account, you should be careful if they offer it on a small trading account. Additionally, if you make a $300 deposit and try to trade with a leverage amount of 400:1, the market makers could remove you from the market before you know it. The 400:1 leverage means that for every $1 equity, you can trade up to $400, which is enormous.
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What is the best leverage in forex for a beginner?
The littlest leverage is most advised for beginner traders and even experienced traders. The idea is to mitigate your potential for more losses as much as possible instead of focusing on your potential to make huge profits.
Beginner traders quickly get into the pitfalls of forex leverage, mainly because they are first attracted by the potential to make substantial trading returns on a small account. As a result, their profit-centred mindset drives them to choose higher leverage rations that destroy their trading accounts.
Additionally, the quest to make lots of money within a short time fosters the affinity for higher leverage, which also endangers their trading accounts. Interestingly, education-oriented forex brokers like Avatrade provide many training resources for newbie traders to enrich their knowledge base before dabbling into forex leverage. You can open an Avatrade account to access their trading resources and improve your trading experience today.
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