What is leverage in forex?
The first time you learn forex, you may be faced with the term “leverage”, but what is leverage in forex? How does it work, which leverage is best?
Perhaps many such questions arise in your mind. Well, this article might help you understand leverage and get some important tips on using forex leverage.
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What does leverage forex mean?
There is a difference between forex leverage and company leverage. In a company, the meaning of leverage can mean the use of assets and sources of funds by companies that have fixed costs (fixed expenses) with the aim of increasing shareholder potential profits.
Other experts say leverage is the amount of debt used to finance or buy company assets.
While in forex the meaning of leverage is borrowing funds from a broker to increase the contract size of a transaction.
An easy example of an item that costs $1000, with leverage of 1:100, the buyer only needs $10 to get it. Therefore, with leverage, traders who have low funds still have the opportunity to make trading transactions with the help of leverage.
Where does forex leverage come from?
In forex, brokerage companies or those who determine the allowable leverage ratio. However, in some countries, it may be government to set maximum leverage rules that are allowed and must be complied with by brokerage firms. For example in the US, it is set the maximum amount of leverage allowed.
So the policy on allowable leverage also depends on government regulations in regulating futures trading. Referring to these regulations then companies offer leverage to their clients.
So in this case the trader only has the appropriate options offered by the broker. For example, the maximum leverage allowed is 1:500, so the trader cannot choose 1:1000 leverage, he only has the right to choose leverage below 1:500.
Maximum leverage on forex
You can find out the maximum amount of leverage allowed by the broker you choose.
So far as we know, the maximum leverage offered by the broker is 1:3000. This is an insane leverage offering. It may seem profitable for traders, but you must understand the risks of forex leverage.
For brokerage firms, leverage is a marketing tool to attract new traders. Therefore, understanding the concept of leverage is very important because the risk is proportional to the use of high leverage.
How does forex leverage work?
How does forex leverage work, it uses certain calculations and formulas to determine what is called the margin requirement. The margin requirement is the number of funds held by the broker when a trader opens a buy or sell position on a pair.
The MT4 platform supports automatically calculating the margin requirement needed to open a new order. So traders don’t have to bother calculating manually.
This margin requirement calculation also uses the current price to determine the amount of margin requirement needed to open an order.
The formula is Contract size x position size x leverage x current price. So if you see a different amount of margin in your mt4 when opening orders with the same position size, it’s because you got them at different prices.
Does leverage matter in forex?
It is clear that leverage matters in forex, without leverage retail traders, cannot open transactions because they require funds according to the contract size for 1 lot.
So for example the contract size of 1 lot is $100,000, so without leverage, you can’t buy without having $100,000 in funds. And more, without retail brokers, it is impossible for retail traders to trade using 0.01 lots.
So the existence of leverage is very helpful for retail traders to participate in the forex market, trying to profit from currency speculation.
How to choose leverage forex trading?
How to choose leverage The important thing to pay attention to is understanding the relationship between leverage and risk, and leverage with trader psychology.
On the one edge, leverage gives retail traders an advantage because with lower margins they can trade with real contract sizes. But on the other edge, leverage in forex can be high risk.
Relationship Leverage with the risk
The higher the leverage the lower the funds required to open a position of the same size.
It seems profitable at first glance, but in fact, it increases the risk. Because using a high size, it will make the margin level lower.]
Maybe you pay less attention to the margin level on your mt4. It will appear on the far right side of the metric column of your transaction account.
So if you use the max position size, it will require higher margins, and make your margin level drop until it can quickly reach a margin call. Finally, the broker will close your position so that the margin level is above the margin call threshold.
If that happens, the broker forcibly closes your order then you will not get profit but loss. While traders can not just rely on luck alone.
Relationship Leverage with psychology trader
Maybe you are interested in using 1:3000 leverage. If your wishful thinking is by choosing leverage, try looking again at your emotional habits in trading.
If you are the type of trader with poor emotional control, high leverage will only destroy you faster.
When you are dealing with the market, then do an analysis, and be very confident that your analysis will be right in the future. This encourages you to open a high position size because leverage allows it.
If that condition often happens to you, choosing high leverage is not right for you. It is better with low leverage for example 1:100 is the leverage that is widely used by experienced traders.
With low leverage, you do not have the power to open a high position size because a notification will appear, not enough funds on your mt4 screen.
What leverage is best in forex?
If you like investing in PAMM forex brokers, you will probably find many master PAMM traders like to use 1:100 leverage.
With this leverage, the trader has a hundred times the power to increase the potential profit, but it is also worth the risk.
Because with 1:100 leverage if the contract price is $100 it only requires a margin of $1 for one contract size.
Best leverage for beginner
But the best leverage options for beginners are different from those of professional traders.
Perhaps one of the mistakes beginners make when trying to trade forex is choosing high leverage, say 1:3000. It’s a misstep to learn to trade because they don’t have the brakes to stop greed.
The ideal leverage for beginners is 1:10 or 1:20, it will be a new adaptation when they learn to trade well.
With the leverage of 1:10 for example, trading on a contract size of $100, it would take $10 to buy it. This will reduce them if they overtrade.
In contrast, if he chooses 1:3000 leverage it will possible to lead him to trade with a larger position size.
What leverage should I use forex?
Which leverage should be used, all traders decide with the available options. Depending on your needs, if you are a beginner, when you have dared to try on a real account, choosing low leverage is safer than high leverage. 1:10 you can choose if this option is available.
Beginner leverage
However, because most beginners try forex trading with low funds, using low leverage also limits their opportunities to make transactions. Say he started with $100, with leverage of 1:10 meaning he is trading with a contract size of $100000 for 1 lot obviously not enough funds.
However, some brokers offer mini accounts, with a contract size of $1000 for 1 lot. With this contract size, a $100 fund with 1:10 leverage cannot trade 1 lot size because it must have a sufficient margin level for the order to remain active.
Luckily the broker has a minimum position size option of 0.01 lots. So with $100 funds on a mini account, you can start with 0.01 lots for each open position, requiring a $10 margin requirement. It only gives you the opportunity to open the order several times in case of a loss.
Intermediate leverage
For intermediate-level traders, most of them choose 1:400 leverage, this is because they are experienced and can control their emotions, and have better psychology.
Expert trader leverage
While the level of expert traders, most of them choose 1:100 leverage because usually, they have managed large funds above thousands of dollars.
However, there are also experts who choose high leverage for example 1:400 because they use strategies that require aggressive trading to open trading positions. Call it the martingale strategy, and averaging down.
So choosing which leverage to use depends on several factors if classified.
- Your level of experience in forex trading.
- The number of deposit funds that you will spend.
- Trading strategy to be implemented.
- Your convenience in using leverage.
Forex leverage advantage and disadvantage
Using leverage is like using a double-edged sword, if you are not skilled at swinging a sword well, it is not the enemy that you will defeat, but your hand can be cut by your own sword.
Advantage
This leverage offers several advantages including:
- With low margin requirements, you can trade with higher contract values.
- Potential to increase your profit, with a note you are trading with good analytical accuracy.
- It is possible to start trading with low capital.
- The retail trader has the opportunity to take part in forex trading.
Disadvantages
Like you drive at a speed of 60 km per hour will be different risks with a speed of 200 km per hour. Such is the leverage analogy. Leverage can encourage you to increase the lot size because it only requires low margins. And it will automatically reduce margin resistance when prices fluctuate.
- Leverage has the potential to encourage you to trade with high risk.
- Leverage can encourage you to open too many orders or overtrade.
- High leverage allows your account to have a negative balance. That’s usually when the market moves with high volatility and there is a freeze on the broker’s server.
How to use Leverage properly
You choose leverage depending on your comfort when trading, but there are some important rules for using leverage properly.
- Limit 1% or 2% risk on each trading plan. This may be a bit difficult for you, but experts suggest a lower risk limit gives you more opportunities.
- You can use trailing stops for risk protection.
- Don’t break the important rule in point 1.
Final thought
The concept of leverage in margin trading offered by brokers gives retail traders the opportunity to trade in the forex market.
Even some brokerage firms are competing to offer high leverage up to 1:3000. But as a retail trader, you must understand the risks and benefits of Leverage and how to use it properly.
And most importantly, forex trading is a high risk, you have to accept the risk for example losing money due to your losses.
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