How to choose leverage in forex brokers
What Is the Appropriate Amount of Leverage for You in Forex Trading
To get a serious grasp of trading foreign currencies necessitates comprehensive knowledge about the political situations and economies of individual countries, global macroeconomics, as well as the influence of volatility on given markets.
However, the truth is, neither global finance nor economics outplay newbie Forex traders. Rather, the root causes of losses incurred during trading are their knowledge, or lack thereof, of how to utilise leverage.
The biggest FX brokerages disclose data, which shows that a large majority of retail FX customers lose cash. The most probable reason for these losses is found in the misapplication of leverage.
This post will delve deeper into the risks of high levels of leverage on FX markets. Additionally, it will delineate methods to offset hazardous levels of leverage, and it will also educate you on how to select the most suitable level of exposure.
The Risks of High Leverage
Leverage is outlined as a process where a trader borrows cash with the aim of purchasing or investing in something. In forex trading, capital is usually obtained from a brokerage. While FX investors are capable of borrowing substantial amounts of capital on preliminary margin prerequisites, they may also acquire even more from trades that turn out to be successful.
The past experienced multitudes of brokers providing substantial leverage ratios that reached as high as 500:1. This meant that with a $350 deposit, a trader could control $165,000 in currency on the international FX markets.
Despite that, 2010 financial regulations imposed limits to the ratio that brokerages may offer to U.S.-positioned traders. The limitations were to the tune of 50:1, which is still a large amount, considering that with the same $350 deposit, investors will control $17,500.
With this arises the question whether a new-fangled FX trader should opt for a low leverage level (5:1) or be audacious and dive in the exhilarating FX sea with ratios of up to 50:1. Before answering, it’s vital to explore some examples, illustrating the heaps of money that can be obtained or lost with the different leverage levels.
An Example with Maximum Leverage
Imagine Trader Sonya possesses an account with $12,000 cash. She decides to utilise the 50:1 leverage, meaning Sonya can trade up to $600,000. In the forex galaxy, this amounts to six (6) standard lots.
Speaking of Forex lots, there are three fundamental trade sizes.
- Standard lot – amounting to 100,000 units of a base currency.
- Mini lot – amounting to 10,000 units of a quote currency.
- Macro lot – amounting to 1,000 units of a base currency.
The measurement for movements is pip. Every 10-unit change in a standard lot is one-pip movement.
Since the trader bought six (6) standard lots, every one-pip movement will cost $60 ($10 change/standard lot X six (6) standard lots). If the trade results against the trader by 40 pips, the trader would end up losing 40 pips $60 = $2,400. This equals to 20% of the entire $12,000 trading account.
An Example with Less Leverage
Let’s go to Trader Jax. Rather than maximising the leverage of 50:1, Jax selects a much lower one of 6:1. If Jax possesses an account with $10,000 cash, he will be able to invest $60,000 in currency.
Each of Jax’s mini lots will cost $10,000. With mini lots, every pip amounts to a $1 change. Because Jax has 6 mini lots, every pip is a $6 change.
If the trade fails with the same amount, by 40 pips, then the investor will lose 40 pips x $6 = $240. This is only 2% of the total.
How to Select the Most Suitable Leverage Level
Broadly respected rules should be the first thing that investors should analyse before choosing a leverage level. These include:
- Keeping the leverage levels low.
- Limiting the capital for each position taken to 1%, 1,5%, or 2% of the entire trading capital.
- Utilising trailing stops to diminish downside and shield capital.
Forex traders have to select the leverage levels, which make them most comfortable. For instance, if Sonya is unadventurous and is not a fan of immersing into risks, or if she is still learning the nitty-gritties of currency trading, a lower level (5:1 to 10:1) is perhaps the most suitable.
Limit or trailing stops equip investors with a trustworthy way to lessen their losses when a trade fails them. By making use of trailing stops, investors can safeguard limiting financial harms if an investment fails them. These limit stops are also critical since they aid in diminishing the emotion of trading (a principal cause for trade failure) and permit punters to deviate from their workstations without any emotion.
The End Result
Settling on the appropriate leverage level hinges on an investor’s expertise and experience, risk acceptance, and comfort when operating on the worldwide exchange markets. New-fangled investors need to acquaint themselves with the specific terms and remain conservative as they progress their knowledge and obtain experience.
Restricting the capital for every position, utilising limit stops, and maintaining positions small is a decent beginning to grasping the suitable way to manage leverage.