One of the main advantages of trading Forex is that high leverage is easy to find in comparison to stocks or cryptocurrency. It is basically a concept of borrowing money from the broker so that you can multiply your trades for a huge amount of profit.
Let’s say you have a broker that gives you 100:1 leverage and you have $1,000 invested in a currency. If the currency pair jumps up by a mere 1%, you can sell it and double your money.
Of course, since it is still borrowed money, it also has the potential for huge losses that will put you in debt. If that same currency pair instead went down a fraction of a percent and you decide to bail, you could be down hundreds of dollars.
Understanding Your Pip Value
While leverage is basically borrowing money, don’t think of it as adding money to your account balance. Instead think of it as if you have a rocket booster added to every trading decision, leading to increased size to your pip trade.
Since most forex calculations will show up in pips, you will need to keep up with your leverage amount to grasp how much you are trading. If you have a USD lot size of $10,000, you will have a pip of $1. Leveraging at 20:1, you will have a $20 pip.
When trading a currency pair, you will need to pay attention to the quoted price. If the USD is the currency you are buying, the pip price will also be in USD. Switching to other currencies can mix things up, so give special attention to that detail when trading with tons of leverage.
Is Leverage Necessary for Forex?
Taking a look at hourly graphs for most currency pairs, you will likely only see movements at a fraction of a cent. Assuming that you have the amount of capital as the Average Joe, you just be pushing around pennies for every pip.
If you could magically take a $500 trade and turn it into a $50,000 trade, then you could actually make a livable income. This is why leverage is necessary for many traders.
For high-rollers, they will have the same trading power as those borrowing leverage. On the flip side, they won’t have to worry about interest or payments if they take a big loss. For these people, leverage isn’t so necessary.
Leverage Amplifies Your Risk
Since some brokers offer out-of-control leverage rates of up to 1000:1, it is no surprise that some users can end up bankrupt. Anyone who is reasonable probably wouldn’t trade beyond something like 10:1 or 20:1 leverage ratios.
A broker that offers unusually high leverage is simply setting up a debt trap for impulsive investors. There are always people that come in with a few hundred bucks hoping to make a quick fortune and end up with a negative bankroll.
Depending on your broker, a margin call may be issued if your equity hits a certain amount. This will make you either liquidate any other positions you have going or you will be demanded to add more money to your trading account. If the broker sees fit, they may force your account to pull out of all positions.
Taking advantage of stop losses will be able to mitigate sudden losses when playing with high-leverage trading. Of course, it would have to be used alongside market knowledge and a brilliant strategy to make it work.
Avoiding long-term trades, even overnight ones is also highly recommended. Having that big wide trading gap with a 100:1 margin is like falling asleep at the wheel while going at full speed. Keep yourself at the computer for high-risk trading.
Preparing For High-Righ Trading
As if you were learning how to play poker, it is best to simulate with fake money before going to the live market. There are practice accounts and tutorials available so that you may prepare to handle hypothetical situations without foolishly losing real money.
Once you do find yourself in the live market, you will also need impulse control and learn when to cut your losses. No matter how your emotions sway you, some trades are simply bad ideas and its better to pull out and reinvest at a slight loss than lose it all.
It is also important to keep away from currency hype unless it is really solid facts. Especially when harnessing the power of leverage, even minor trades will become intense enough to lose your mind.
Paying Back a Failed Investment
If you find yourself losing out on a major trade while using leverage, you will obviously owe the broker a certain amount. If your balance had completely wiped clean and you were trading on margin, there is even a chance that you have an alarming negative balance.
If you are not trading on margin, your exchange may just force sell your trade if it hits a certain threshold and takes your balance to $0. This would at least avoid any sort of debt and your account is free to reload and try again. This is will, of course, depend on the rules of the broker and any local regulations that might apply.
Just like any other type of debt, enforcing payments will always depend on the location of the broker in proximity to the user and who is regulating the broker. If you happen to be in the same country as the broker, you may easily face legal action or harassment by a collection agency.
Interesting enough, EU-based exchanges are regulated by the latest ESMA rules. This includes the protection of users from negative balances so that irresponsible trading doesn’t happen in the first place. This is a big incentive for starting trading with European brokers.
As it should be common sense, leverage isn’t something to be feared if the user knows how to properly manage it. For someone who doesn’t know much about finance or is impulsive, it is best to stay away from high-percentage leveraging.