Forex trading with leverage presupposes borrowing money from your broker to increase your market exposure. For many people, it’s the only way to start their trading career, yet it is a trading type that should be approached with caution.
In this article, we’ll describe forex trading with leverage in greater detail and discuss its pros and cons.
Let’s get started!
What is forex trading with leverage?
As mentioned, forex trading with leverage increases your market exposure with your broker’s money to enhance your income. The initial investment you want to trade with is called margin. You may also think of margin as the amount of money you have to put into the deposit in the system.
For example, if you need to make a USD 10,000 trading investment and the platform margin is 10%, you will only have to deposit USD 1,000 to start trading, and your broker will borrow the rest of the money.
Most brokers have margin levels of ten-to-one, thirty-to-one, or fifty-to-one. This way, you can trade the whole house to magnify profits while depositing only 10%, 30%, or 50% of the initial amount required.
Yet, it is also important to note that losses are magnified, so trading with leverage is not always safe and requires attention and skills.
To manage risks, traders usually use techniques like setting stop-loss orders, appropriate leverage ratios, and diversifying trades. These strategies allow us to mitigate potential losses.
As leverage is essentially a loan provided to an investor by the broker, some brokers initially limit the amount of leverage used with new traders until the latter builds up a reputation in the field.
Strategies to Mitigate Leverage Risk in Forex Trading
There are various ways traders can mitigate losses when trading forex with leverage. For example”
Lower Leverage Ratios
Usually, a broker lets you decide between different leverage ratios, and it is considered safer to select more conservative options. For example, is a broker offers a ration of 100:1 and 10:1 it is better take 10:1.
Stop-Loss Orders
Stop-loss orders are an automated function on trading software like tMT4 and MT5, which can be used to manage risk in leveraged forex trades. Such a feature automatically closes a position when the market price reaches a predetermined level. This way, you can limit the amount of loss in the trade.
Position Size Limit
This strategy limits the amount of capital exposed in any single trade. This way, you can manage leverage risk by controlling the size of your positions relative to your account balance. For example, some traders prefer risking only 1% of their assets in every trade.
Diversified Trades
Diversification presupposes different currency pairs. By doing so, instead of focusing on a single position, traders reduce the impact of adverse price movements in one market on their overall account.
Margin Levels Monitoring
When you monitor margin levels closely, you ensure that you are not close to a margin call. This great approach allows you to manage your leverage risk and avoid sudden forced closures of positions.
Risk-Reward Ratios
Adopting a clear risk-reward ratio for each trade helps to ensure that the potential reward outweighs the risks. As an example, you could set a rule that is a 2:1 risk-reward ratio. This means that for every $1 of risk, you want to make at least $2 in profit. This strategy helps focus on trades where the leverage makes absolute sense.
These are the most common ways to hedge risks when trading forex with leverage. Yet, a clear understanding of which strategy to choose requires experience and skill.
Education and Practice as a Key to Success
Many trading platforms allow for the demo mode of trading and different testing tools, allowing you to check your trading strategies based on live and historical data. This way, you can use virtual money to simulate real market conditions without the risk of losing actual money.
Also, there are the whole range of demo platforms that let you develop your skills as a trader in unreal environments. These strategies are used not only by starters but also by seasoned traders wishing to test their assumptions.
Summing up
As we see, forex trading with leverage is an excellent option for traders who are on a budget to start trading in positions of their interest. Yet, it is also a risky endeavor since in case of an unfavorable market situation, traders’ losses are also multiplied. Therefore, it is necessary to learn and practice the key principle of sage trading.
