For adventurous and opportunistic traders, more aggressive forex trading strategies may offer appeal due to the increased earning potential that can come with those risks.
One such strategy is trading forex using leverage. If you’re unfamiliar with leveraged forex trading, it’s important to educate yourself on how leverage works and how traders might want to incorporate this trading option into their overall strategy.
Read on for eight important facts every trader should know before attempting leveraged forex trading.
1. Leverage involves making forex investments with borrowed money.
When forex traders decide to open positions using leverage, they are essentially borrowing money from the broker to open that position rather than using the principle in their account.
Leverage is usually used when all of your account funds are already invested, preventing you from opening a position to take advantage of a potential profit opportunity. Your brokerage will grant you a specific amount of leverage based on the value of your account, which is based on the ratio of leveraged funds to account funds that the brokerage allows.
2. The potential rewards of forex leverage can be significant.
Because leverage can dramatically increase the amount of money available to invest in the forex market, your earnings potential through leveraged forex trading can be significant.
If you have an account balance of $1,000 but use a brokerage with a 20-1 leverage ratio, you could be able to invest up to $20,000 in leveraged positions. If those positions earn a 2 percent profit, you can sell off that position and have an extra $400 in your account, a strong profit for just a $1,000 investment. That new balance would then allow you to invest up to $28,000 in leveraged positions.
3. The risk involved in using leverage can be devastating.
While traders are attracted to leveraged forex trading because of the potential riches, it’s equally important to understand how that leverage can quickly lead to losses. Imagine the same scenario, except instead of a 2 percent profit, you suffer a 6 percent loss due to a sudden swing in currency pair pricing.
That 6 percent loss would cost you $1,200. After selling off your position, your account funds would be gone, and you could potentially owe your broker $200 to cover your losses—a far greater total loss than if you had only lost 6 percent of your $1,000 principle.
4. In exchange for borrowed investment funds, your broker will charge you interest.
Because your broker is lending you money, you can expect to be charged interest on those funds.
Many forex brokers charge a fee between 1 and 2 percent annually—although you should always read the fine print to make sure you know the cost. Some brokers will charge very high rates on their leveraged funds, potentially 5 percent or more. This can greatly reduce the profit potential available through leverage, especially if you hold the position for a long time.
5. Leverage is typically less volatile in forex markets than in other types of markets.
While the risk involved in using leverage needs to be taken seriously, forex traders can take heart that forex markets typically experience less volatility than stocks and other markets—which can create less risk than what other traders using other types of leverage will experience.
6. Margin represents the minimum balance required to keep your account in good standing.
Leverage and margin are similar terms every forex trader should understand. While leverage refers to the amount of loaned currency you’re able to invest, margin refers to the minimum account balance that must be maintained to avoid certain issues with your account.
Maintaining this margin maintenance will avoid account restrictions and allow you to trade freely with your available leverage.
7. If your losses get too steep, you could be forced to sell at a loss.
If your balance falls below your margin maintenance level, you could be issued a margin call that requires you to deposit funds and cover this debt.
If you don’t deposit funds, or if your losses are too steep, your brokerage may even force the sale of certain assets, which could lock in losses on your leveraged positions.
8. Momentum indicators and sentiment analysis tools can be helpful when seeking out leverage opportunities.
Because you get charged interest for the leverage you use, many traders are eager to use leverage only for shorter-term forex trades—otherwise, the interest charges incurred by a long-term position could cut into your profits and upset the balance of risk and reward.
Relative strength index, momentum indicators, Bollinger Bands, and moving averages can all help identify potential price swings that could create quick windows of opportunity to capture profits through the use of your available leverage.
While leveraged forex trading involves considerably greater risk than other types of forex action, an experienced and disciplined trader can use this trading approach to take advantage of timely forex opportunities while also maximizing their earnings potential. Although the risk should be taken seriously, savvy traders can use stop-losses and shrewd analysis to make the most of their leveraged positions.
The information provided herein is for general informational and educational purposes only. It is not intended and should not be construed to constitute advice. If such information is acted upon by you then this should be solely at your discretion and Valutrades will not be held accountable in any way.