For quite a long time, Forex trading has proven to be popular, drawing new and seasoned traders in to profit from these changes that currencies have within themselves. Among the many attractive features of trading currencies is being able to harness leverage.
A financial tool, it provides traders an edge, letting them control larger positions using relatively minimal capital amounts that can multiply their return. Though everyone knows that leverage significantly increases profit, it has significant risks too.
In the article, we will talk about what leverage is, how leverage works in forex trading, benefits of leverage, its risks, and ways for proper leverage usage.
Leverage is the use of borrowed capital to be able to amplify potential return on investment. This, of course, for the trader, means that they are then enabled to command control over a much larger position than they would alone using their own money. That being said, when a trader makes his trading account worth $1,000, and applies a leverage ratio of 100:1, he is then allowed to be controlling a position worth $100,000.
Leverage is provided by Forex brokers so that traders may trade with substantial amounts of capital on margin. Margin is, therefore, considered to be the amount of money that the trader has to deposit to open a position. With the leverage ratio, it merely tells you how much bigger the traded position can be in comparison with the margin.
For simplicity, let's take an example:
In this instance, the trader would only need to have $1,000 in his account to open a position worth $100,000. That's the point of leverage: to be able to trade on margin.
The most significant advantage of leverage is the increase in profits. Margin trading means that even small movements in the market might bring in massive profits. Suppose that a trader, using a leverage at 100:1, reaps a profit of 1% on a position of $100,000. In this case, they would reap a profit of $1,000, which would represent a return of 100% from the initial investment of $1,000.
Leverage enables the trader to enter the currency market with a much more modest initial investment. This way, trading is accessible to more individuals since more people can venture into currency trading without requiring much capital.