How to use Leverage in Forex Trading

Leverage simply means working with borrowed funds. With leverage, you can increase the size and volume of your trades. Equity and Forex brokers both provide their clients with leverage to increase their clients’ trading volumes. The broker will charge you a commission for providing this service to you, which is commonly referred to as a margin. The broker completely covered, as the funds in your account are held as collateral against any possible losses suffered while trading.

Leverage for the Forex Market:

Working with leverage is very common when trading on the Forex market. The availability of leverage is substantially high and a client can even start a trading account with a small investment. However, leverage must be used only with its logical limits. Overuse of leverage in Forex trading has caused many traders and brokers to end up suffering heavy losses.

In the USA the Forex regulating bodies have set fixed ratios for trading in the forex markets. The current leverage ratio stands for 50:1 for major currencies and 20:1 for the rest, however the ratio outside the USA could be as high as 400:1.

How does Leverage in Forex Market actually work?

Let’s assume you make a transaction of Euros, traded against the dollar. The leverage in this trade will have a ratio of 30:1. So, with an investment of $1000, you could be selling Euros for $30,000. Now, you might have a strong feeling that the Euro will lose value to the dollar. Your profitability will be calculated on the basis of a pip: the smallest price movement in terms of currency fluctuation, calculated on the basis of decimal point movements. If the Euro actually falls, as you predicted, even a single point’s decrease could count as a 1% move in your favor.

So let’s say you purchased Euros at an exchange rate of 1.35 to a dollar, and later you managed to sell Euros at an exchange rate of 1.345 to a dollar. Your profit would be 50 pips, or 50% . If the gain value of each pip is $8 (minus leverage margins), your profitability would be $400.

It is also advisable to also work with a predefined stop loss, in case markets don’t do what you predict. The stop loss could protect you from losing a lot of money. It is always advisable to set up a stop loss at an average of 50 to 60 pips.

Tips on how to use the Forex Leverage:

  • Trade only with stop losses. They’ll save the day in a worst case scenario.

  • Choose a comfortable degree of leverage. It’s always advisable to trade within a ratio of 50:1 or 30:1.

  • Learn to accept when you’ve gone wrong; traders who can’t book their losses often end up seeing their entire investment wiped out. It’s better to settle at a marginal loss and recover it when the markets are more favorable.

  • Trade only within your limits, so you don’t drain your investment when things go wrong.

  • The leverage available in the Forex Markets is immense, and can lead to enormous profits, as long as you trade within your means and keep the risk factor in mind.