Let’s recognize the following leverage in forex trading, to understand more deeply before plunging into forex trading.
Read through to the end of this Financialku article.
Get to know Leverage from its Meaning
Leverage is a factor that we often encounter in forex trading that we do not encounter in other investment platforms. If you use it well, leverage can maximize profits even if your capital is limited.
But, like most features in investing, leverage carries a high level of risk. You better understand how it works. In simple terms, leverage can mean the use of borrowed funds to maximize the profit potential of trading activities .
Leverage can be analogous to you borrowing money with certain guarantees that are proportional to the nominal loan that we get.
We call that guarantee margin. Leverage can suppress your capital so that the profit potential increases.
Without leverage , you have to spend the amount of the contract value at the time of the transaction. With leverage , you only need capital starting from 1-2% of the transaction value. But, if you lose , the loss you bear is big.
Types of Leverage
Here are 2 types of leverage that we all need to know.
Margin leverage affects the capital you spend, not focusing on profit and loss . The greater the leverage you use, the smaller your capital. The calculation of the leverage margin is:
The margin you need is to multiply the leverage by the transaction value
You use 1:100 leverage to trade contracts worth US$200,000. So, the capital you need to spend is:
The required margin is: leverage x transaction value
i.e. 0.01 x US$200,000 = US$2,000
Then you only need a margin of US $ 2,000 only. If you trade GOFX contracts using this feature, you need 2% of the total transaction value of GOFX gold and forex spot contracts.
Meanwhile, for GOFX crude oil futures contracts, you need 4% capital of the transaction value.
You can calculate nominal real leverage with the following model:
Real leverage = total transaction value: total capital you have
You have a margin of US$20,000. Then you open 4 lots with a value of US$200,000 per lot. Then the real leverage is:
Real leverage: total transaction value: total capital you own
ie (US$200,000 x 4) : US$20,000
ie US$800,000 : US$20,000 = 40
So, you have made a leveraged transaction with 50x greater than your margin .
Advantages and Disadvantages of Using Leverage
The concept of leverage in trading is indeed profitable
But it can backfire if you’re not careful with it, especially if you have high leverage .
High leverage causes the minimum margin paid for each transaction to decrease.
Advantages of Leverage Trading
Here are the advantages of trading leverage that you can get:
You can start trading with a capital that tends to be small
Before the leverage feature appeared, most trading activities were only carried out by the rich. Big profit potential cannot be obtained by small traders .
when finally leverage was released and many brokers adopted it, many people joined. Currently, students can also trade .
Interest Free Leverage
Margin is like collateral for traders to get a loan from a broker. The funds you receive do not contain any interest so there is no need to worry about charges or other returns.
Traders simply trade using the funds received. Brokers have been paid through spreads and commissions.
Bigger Profit Potential
The leverage feature allows you to open multiple trading positions and the impact on the potential profit is also greater.
This is because the capital issued is smaller than the original transaction value.
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Disadvantages of Leverage Trading Forex
Here are some of the leverage risks you may experience:
Leverage can affect a trader ‘s emotions when trading .
When they see a lot of money in the account balance (even though it is the result of leverage ), it is easy for someone to make trading mistakes .
One of them is over- trading . In fact, the key to successful trading is money management .
You can avoid over – trading through two things:
- Avoid too high leverage . It’s best to limit it to 1:100 or 1:200 only.
- Avoid non-integer leverage , as 1:777 or 1:888 non-round numbers tend to fool the brain. Most people will round 777 to 700 and 888 to just 888. however, both values are closer to the top.
The risk of loss is greater than expectations
Leverage offers great profit potential. But, like any other investment, a large profit is directly proportional to the high risk. In high leverage , miscalculations can result in large losses.
To avoid fatal mistakes, it’s a good idea to set a stop loss in each position. Loss positions will be closed automatically if the specified limit has been reached, so traders do not need to calculate and close them manually.
Margin-Call Risiko Risk
Every time someone trades leveraged , the margin-call feature is also available. Margin-call is a certain margin threshold that must be in the trader ‘s balance .
If the balance is below the margin-call , the trader can close all or part of the position in the trader ‘s portfolio .
The position can be forcibly closed when profit or loss .
You can avoid over-trading by:
- Practice good fund management. Use 2-5 percent of the total capital. The rest is used as anticipation when the price drops.
- Place stop-losses on all existing trading positions . We recommend that the stop-loss threshold is above the margin-call threshold .
Things to Pay Attention to When Trading with Leverage
My financial friend needs to pay attention to the following things. Make sure the broker you choose is supervised by regulatory bodies, such as the FCA (UK Financial Services Authority), CySEC (Cyprus Securities and Exchange Commission), and so on.
This regulatory body requires brokers to have separate accounts with client funds so that they cannot access traders ‘ funds . The regulatory body also carries out strict checks to prevent financial malpractice.
Also, make sure your device is stable and has a fast connection. In addition, the trading platform also plays an important role . The platforms that people usually use are MetaTrader 4 and MetaTrader 5.
Then, you should also avoid opening too many positions at the same time. Instead of profit, this actually harms your account. It ‘s best to open a position with an amount that you can monitor.
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That’s the discussion about leverage in trading . Of course we need to use it wisely.
Before tarding, it would be much better, if you study with the experts so as not to make fatal mistakes.