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Leverage in any Forex Trading Strategy

12 Sep 2023

When you trade in forex (foreign exchange markets), you get leverage while you trade. This is perhaps higher in the currency markets than with any other financial avenues of investing. For example, leverage that you get with trading in forex online trading is much higher than that which you get by trading with stocks. Several traders have heard the word “leverage” often enough, but few of them really know what it means. How leverage works can directly affect the way that trades function, and hence, any potential gains. 

What is leverage?

The concept that explains the use of someone else’s money to trade or enter an investment transaction is applied to forex markets as much as it is relevant to stock markets. However, in currency markets, the leverage you can use is higher, and this is a definite advantage. Still, like all things related to investment markets, you should be cautious of a “double-edged sword”. 

As it applies to forex online trading and the forex markets, leverage can best be explained when traders borrow a specific amount of cash to facilitate investments. Where forex is concerned, the borrowing of money is done from a broker. When you speak of “high” leverage in forex markets, the initial margin requirement for a trader can be a high amount of money to trade in the markets and control huge sums of cash. This is known as “margin-based” leverage. 

Margin Based Leverage 

When you open a demat account for your stock trading transactions, you may start trading by borrowing money from a brokerage for any stock investment you wish to make. Therefore, you take advantage of leverage. You can do this with currency as well and then continue your online trading. In margin based leverage with regard to any investment, traders must place a percentage of the value of the trade with a broker, and borrow the rest. This means, traders place a margin amount and brokers let them borrow the rest of the capital needed for their transactions. 

This is the commonest kind of leverage you may get in the forex markets, and you can carry out trades easily. How does it work? For instance, you may be required to deposit 1% of the total value of your transaction, and this is the margin. Now, let’s say that you wish to trade a standard lot with USD/CHF, equivalent to US$100,000, your margin that is required would work out to US$1,000. Therefore, in terms of margin based leverage, this would work out to 100:1, according to the margin leverage formula. 

The Best Leverage

When you indulge in forex online trading, the leverage that is margin based (although used a lot) does not necessarily have any effect on risk. Whether a trader has to put in 1% or 2% of any transaction value as the margin value doesn’t always impact profits or losses. In forex trading online, this is due to the fact that, for any position, investors may attribute more than the needed margin. Therefore, this is the actual leverage the investor gets, and this may well be the more solid indicator of any profit or any losses. The best leverage in forex markets depends on the investor. For conservative investors, or new ones, a low leverage ratio of 5:1/10:1 may be good. For seasoned investors, who are more risk-friendly, leverages may be as high as 50:1 or even 100:1 plus. 

Use Your Leverage

If you open a demat account to trade in stock markets, you know you have to manage your leverage in terms of the stocks you trade. In the markets of forex, the common leverage used is 100:1, considered high. What this essentially means is that for each $1,000 in your trading account, you are permitted to trade till $100,000 of currency value. There is no need to fear leverage as long as you know how it can be managed. Using leverage to trade in the forex market is a good way to trade and diversify your portfolio. While you are at the investing table, be sure to check on any upcoming IPO to invest in too. 


Related Articles: What Are Cross Currency Pairs And What Do They Mean? | How does a Spread Contract Help in Currency Trading | How Currency Fluctuations Impact your Financial Plan 


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