In forex trading, leverage allows the investor to control a large amount of money with a small amount. Leverage is simply a short-term loan for any High Leverage Forex Brokers accepting US clients that allows you to manage massive holdings with less cash. The forex market may appear monotonous to beginning investors because exchange rates move slowly, especially in comparison to the stock market. But leverage makes the forex market the most flexible and easy opportunity market on the planet.
Consider the case where you believe the USD/INR rate will rise and you want to profit from it. So, if you’re going to buy 1 USD/INR contract at Rs 73.2560, you’ll have to spend Rs 73,256 out of pocket without using leverage (1 typical USD/INR lot is 1,000 units). However, your trading account only has Rs 10,000 in it. Using “Leverage,” you can create endless wealth in forex trading with little cash. Today, we’ll look at how leverage operates in forex trading and how to use leverage to increase your profits.
What is Leverage?
In forex trading, leverage refers to the money you borrow from your broker for a brief period to handle a large position with a small amount of money and maximize your profits. Leverage is calculated as a percentage of your investment in forex trading, or “X.”
So, if you have Rs 10,000 in your currency trading account and your broker offers ten times leverage, you can trade up to Rs 1 lakh. Conversely, if your broker allows you to trade up to Rs 5 lakhs, you can use a fifty times leverage. In forex trading, leverage can be as high as one hundred times, depending on the forex margin. In forex trading, several brokers offer a lot of leverage for a tiny currency margin.
What is Forex Margin?
If leverage refers to a short-term loan from your broker, forex margin refers to the downpayment you must make with your broker to obtain the loan, i.e., leverage. A tiny fraction of the total position is used for forex margin. The link between forex margin and forex leverage is inverse. So, when the forex margin need is only 0.25%, the broker is ready to offer a leverage of four hundred times or 400 times; but, when the forex margin condition is 10%, the leverage offered is only 10x, or 10 times.
How does Leverage work?
Now that you have learned the fundamentals of leverage in forex trading let’s see how leverage works in practice. An accountant, Mr. Rob, anticipates a rise in the USD/INR currency and purchases the USD/INR 1-month futures contract, now trading at Rs 73.3834. However, he only has Rs 10,000 to keep as a forex margin. He acquired 17 lots in Intraday using the margin calculator and the substantial leverage given by his broker.
As projected, the USD/INR improved from 73.3834 to 74.3834, and Rob got a 170% profit. The Rs 9,979 in the previous example is the needed margin or security to be kept with the broker, and the broker offered Rob 120x leverage by enabling him to hold a stance of Rs 12.47 lakhs against Rs 9,979. As a result, Rob made a 170% intraday profit, far more than anything mutual funds or stocks could deliver. In forex trading, this is the potential of leverage.
Is Leverage a Two-Edged Sword?
While forex leverage can make an otherwise dull currency market more fascinating and appear to be a good deal, keep in mind that too much sugar can lead to diabetes. If the USD/INR had fallen from 73.3834 to 72.3834 in the case above, Rob would have lost his whole Rs 10,000 investment in a single day. A small drop can deplete the capital investment when working with leverages as high as 120 times. In Mr. Rob’s situation, his loss rose with every little drop. As a result, you must exercise extreme caution when choosing a forex leverage ratio. To counter the double-edged sword aspect of leverage in forex trading, you should also have a strong risk management system.
Best Leverage Ratio for Beginners
Without a doubt, leverage is the primary draw of the forex markets. Traders who do not use forex leverage may have to wait months to see a 10% change in their holdings. However, as inviting as leverage may seem, it is a risky idea in forex. Keep the following three rules in mind when choosing the appropriate leverage ratio:
- Always start with little leverage.
- To safeguard your capital and limit your losses, always utilize a stop-loss order.
- Each trade should only be worth 1% to 2% of your whole capital.
A formula cannot determine the best leverage ratio. It depends on your risk profile, how much money you’re willing to risk, and how much volatility you’re okay with.
Best Way to manage Leverage Risks
Using a stop-loss on each trade is the best strategy to control high leverage risk. Let’s take a look at how stop-loss works to reduce your losses.
Returning to Mr. Rob’s prediction that the USD/INR would increase from 73.3834 to 74.3834, Mr. Rob purchased 17 units of USD/INR at Rs 73.3834 to make a huge profit. However, this time, his prediction was incorrect, and the USD/INR began to depreciate. Rob’s loss was growing with every little drop. However, being a savvy forex trader, Rob set a stop-loss at Rs 73.2500.
A stop-loss is a tool that allows you to limit the amount of money you lose. Even if the USD/INR falls to 72.3834 in the example above, because Rob has a stop-loss of Rs 73.2500, the system would automatically cancel his position once the USD/INR reaches 73.2500. So, even though he could have lost all his money, a stop loss allowed him to limit his loss to Rs 2,268.
To summarize, forex leverage and forex trading may appear difficult at first, but just like anything else in life, you must practice becoming a great trader. The more you learn, the more chances to make cash will open for you.