They say that when the purpose of a thing is not known, abuse is inevitable. Ignorance of the real essence of leverage is one of the major reasons forex traders lose their funds.
Before the forex market became as popular as it is today, traders in the past could not access the forex market. This is because for you to trade the forex market as an individual, you needed to have at least $10000 to trade. Most traders could not afford that amount. And because of this, trading the forex market was limited to big financial institutions.
But as a way to get more people to make a living through trading the financial market, brokers thought it wise to support retail traders by giving them access to trading capital in form of loans. This means that traders no longer have to wait till they have $10000 before they can trade the markets. You can trade the forex market with as little as $100, $200, or $500. The broker loans you funds in order to give you wider exposure to the market. This is what is called leverage.
For instance, if the broker provides you with a 1;100 leverage ratio, and your trading capital is $200. When you multiply it by 100, you have a buying power of $20000. This means that if the value of your trade goes up by 1%, you gain $200. Without the leverage, 1% of $200 would only give you $2. The effect of this is that you have the potential to make more gains if the trade goes in your favour and the losses can also be amplified if the trade does not pan out as expected.
Leverage is intended for you to make substantial profits. But if not properly used, it can cause more harm than good to your trading account. On a $100 trading account for instance, if you open a position with a 0.10 lot and the trade goes up in your favour by 40pips, you gain $40. That’s a whopping 40% on a single trade. But if the trade goes against you by the same 40 pips you lose $40 which is also approximately 40% of your trading account. Now you are left with $60 Think about it. You are supposed to be trading like a professional trader and not a gambler. To be really safe and survive the forex market, it is advisable for you to use a low leverage of not more than 1:5 until you grow into a more professional and experienced trader.
The challenge is that most amateur traders get greedy and abuse how they use leverage. But seasoned traders do it differently. Here’s a peek into how professionals trade with leverage.
Professional traders use leverage in less volatile markets
Trading volatile instruments like Gold or Bitcoin with high leverage can amplify losses faster if the trade goes in the opposite direction. Instead, they prefer to use leverage to trade assets like currency pairs. Not all trades are high-probability trades. So instead of using leverage on all their positions, they wait for the best trading opportunities to increase their chances of making more gains with reasonable leverage size.
To master the art of consistent profitability, get started the right way by first learning how leverage works and how to spot high-probability trades. Join the free training now.