Forex trading is one of the largest financial markets in the world. With over $4.5 trillion exchanged daily, Forex trading offers traders a good chance to make more money. However, anything that offers huge potential for profits also comes with huge risks for losses. Depending on the strategy you employ, you can either reap big or suffer hugely. One such common strategy used in Forex trading is leverage. Before you commit yourself, it’s important to understand the advantages and disadvantages of using high leverage.
That said, below is a detailed guide about high leverage.
What is high leverage ?
Popularly known as margin trading, leverage is a system that allows a trader to boost their account with borrowed funds. That way, a trader can access higher positions than their capital investment. In leverage, a trader is required to put in a specific portion of the position. The position will depend on several factors and changes between platforms, instruments and brokerage firms.
How it works
Leverage is provided by brokers to potential traders. As a trader, you can choose from the various degree of leverage with the lowest starting from ratio 1:50 and the highest going up to 1:1000. For instance, if you invest $50 with high leverage of 1:1000, you have the potential to a trader at $50000.
Related: High Leverage Forex Brokers
Small investors are attracted to this strategy since they want to earn big in a short period. Since leverage is a risk, you should have the necessary experience required to effectively handle it. Below are the pros and cons of using high leverage in forex trading.
1. Low capital investment
This is far the most common reason why investors are easily attracted to leverage trading. Before leverage was introduced, only wealthy investors had the opportunity to earn huge. This is no longer the same since the introduction of leverage. Depending on your knowledge and experience, any trader can earn big in forex trading. Using leverage allows a trader to increase their capital efficiency.
Here, your capital is like an asset with the potential to earn a profit. For instance, if you can earn $300 in three days using the unleveraged positions, leveraging will give you the potential to earn the same amount in a short period. As a result, you can re-invest your capital over and over again to increase your yields.
High leverage is a form of a loan from a brokerage firm. However, this loan doesn’t come with any form of interest. As a trader, you can receive as many funds from your broker without fear of incurring an interest.
3. Huge Profits
Leveraging allows making big profits in a short period. It doesn’t matter on the amount of money you have invested as any trader can make more money with less effort. The essence of leveraging is to grow profits by doubling the stakes. If you want to earn more, you only need to increase your capital input. Even with $50, you have the chance to earn as higher as $50000 with the help of high leverage.
4. Mitigate against low volatility
Volatility offers good chances to make profits, unlike stable instruments. High leverage has the potential to moderate the unstable effect of low volatility. As a result, leveraging can deliver huge profits for small transaction positions. With leveraging, even small changes in marketing pricing can ignite something bigger.
1. Heavier Losses
While leveraging gives the potential to make big profits, it also increases the chances for huge losses. Small losses can be huge and bigger profits can be smaller. When trading using high leverage, don’t expect the prices will always move towards your prediction.
2. Constant Liability
Once you receive leverage from your broker, you must meet the needs of this liability. You must pay the principal amount regardless of the extra costs you will incur. Whether the transaction increased or declined, you must pay for the principal amount.
3. Margin call risk
There are certain marginal conditions to be met before you receive high leverage. Depending on your investment, you must fulfill a certain transaction size set by the broker. In case you are unable to meet the required, the broker may prompt a marginal call. As a result, your portfolio may automatically become liquidated. Even those positions that earned huge profits are closed before time.
The bottom line
High leverage is like a double-edged sword. While it improves the chances of earning huge profits, it can also wipe out your sideline completely. As a trader, its wise to choose leverage that works best for you.