Leverage becomes a feature some traders consider when choosing a broker. However, is it wise to just make use of the highest leverage offered by a forex broker?
Leverage becomes one of feature some traders consider when choosing a broker. Broker usually offers leverage ratio 50:1 or even as high as 3000:1. By trading using leverage, trader is not necessarily depositing too much money for capital. Leverage is also good for a beginner who does not much capital to start trading.
But what is leverage? Leverage is the ratio of the trader’s fund to the size of the broker’s credit. In other words, leverage is borrowed capital to increase potential profit. In forex, traders use leverage to get returns from the fluctuation in exchange rates between two currencies.
How does leverage work? If you decide to use leverage ratio 100:1, it means the minimum margin requirements for the trader is 1/100 = 1%. Using a 100:1 leverage ratio means you are required to deposit 1 percent of the total value of trade in your trading account. It means you are possible to trade for up to USD100 for every USD1 in your account.
For instance, it looks like leverage is very beneficial for traders. A trader is only obliged to deposit a little amount of money, compared to the total value of trade. Leverage also helps a trader to gain a more significant amount of profits. But first, you need to remember, the higher the leverage ratio is, the higher risk you will face.
The Risk of High Leverage
A broker might offer you high leverage but it does not always mean good. Leverage can also backfire you because it will magnify not only your potential profit but also potential loss.
We understand that high leverage might be very tempting. Leverage makes a trader feel like having more power than the actual circumstances. This is also very dangerous for the beginner. They will take risk of loss for granted due to the big amount of capital from leverage. They also will enter many positions, tend to overtrade, and multiply risks of loss.
Another risk of using high leverage is when traders getting a margin call. A margin call is a warning system from the broker every time your balance equity is at the same amount as your used margin. Your positions will be all closed when your account balance left as much as your used margin.
Because of these reasons, leverage oftentimes becomes friend-enemies for traders. Yes, leverage can be your best friend, magnifying your profit into a significant amount, and allows you to trade in a big position. But leverage can also be your enemy if you do not use it right.
So How Much is Ideal Leverage?
There’s nothing like ideal leverage. What you need to do is reviewing before choosing a leverage level. You can follow these three rules:
- Stay patient in low levels of leverage.
- You can use trailing stops to reduce downside and protect your capital.
- Limit your capital to 1-2 percent of total trading capital on each position you're taking.
Besides those rules, what you need to remember is to use the leverage level you’re most comfortable with. Choose your leverage level based on your profile risk. If you’re more conservative trading who avoid too much risk, pick low leverage, like 5:1 or 10:1 But if you are a more moderate trader, who’s challenged by risk, you can pick higher leverage like 30:1 or 50:1.
You also need to use a stop loss. It will help you reduce the risk of loss when a trade goes in the opposite direction than you predicted. It will also help traders reduce the emotional obstacle from your trading desk.
An effective way to prevent the use of high leverage is to have a realistic profit expectancy. If you trade with small capital, don't expect to grow it exponentially in just overnight. Try to understand that your profit rate is in line with the risk rate. If you already have the right state of mind and are ready to start small, choose your broker among these lowest deposit forex brokers.