Forex trading leverage is the ability for a forex trader to borrow a certain amount of money needed to invest in financial instruments from his/her brokerage firm. While using leverages, traders are given the ability to increase the size of their trades and investments and also take advantage of any rising opportunity in the forex market. In the forex market, traders and investors use leverages to profit from the dynamic nature of the forex market and the fluctuation that occurs in the exchange rates between countries. Leverages are given to margin account holders while using funds in the account as collateral.
How leverage works
There are different amounts of leverages offered by forex brokers. Most leverages range from 50:1, 100:1, 200:1 and as high as 1000:1 depending on the broker being used and the trader's trade size position. A 50:1 leverage signifies that a minimum margin requirement for a forex trader is actually 1/50 which means that the trader is required to have for minimum of two percent of his/her total value of trade available as funds/money in his trading account. Forex trading leverages are often known to increase profits but can also magnify losses when associated with using high leverages. The following are the advantages and disadvantages of trading forex using leverages.
Pros (advantages) of forex leverages
Increases forex trading profits
The basic advantage of trading forex with leverages is that it gives forex traders the ability to trade forex while making a whole lot of profits in return. Leverage provides a greater yield of returns with minimal efforts. Since a leverage has no bounds in the type of financial asset being traded, it provides a medium where traders yield profits by just staking a minimum initial deposit. Leverages offer traders the opportunity to double their initial trading amount used as trade setup in just minutes. When dealing with a long-term investment, leverages which are borrowed funds is always a stepping stone to boosting all available capitals when properly managed. For example, a forex trader who just has a deposit amount of one thousand dollars in his/her account can actually trade forex with fifty thousand dollars with the help of leverages.
Upsurges capital efficiency
Leverage have in the long run proven to not only increase profits but also increase capital efficiency. When trading forex with leverages (borrowed funds), if it originally took a forex trader a maximum of two months to generate profits and returns with personal funds, a broker’s leverage can get the same trader to make double profits in a shorter period of time thereby increasing capital efficiency. This simply signifies that a forex trader’s capital or funds can be re-invested on several occasions in future transactions thereby yielding more returns and profits. With this, we can say that leverages not only provides greater profits in a short trading period but also generate a considerable amount of return over a short period of time.
Remedy against low volatility
One major advantage of forex trading leverage when it comes to trading forex is that is has proven to be a high remedy against low volatility. Volatile forex trades are seen as those that yield greater profits because the market situation of these assets is more dynamic than the market of other instruments. Due to the careful nature of forex traders when trading currencies and factors that cause price fluctuations, the forex market experiences low volatility at these points in time. This is where forex leverages come in. leverages have the ability to counter the effects of low volatility simply by generating greater profits from smaller trade transaction sizes. When trading with high leverages, a small movement in prices can become significantly important where forex traders can give more attention to less significant degrees of price movements.
Cons (disadvantages) of forex leverage
Causes heavy losses
Forex trading using leverage can cause a lot of damage to a trade and the account of a trader in general. Although leverages come alongside a reasonable amount of profits, the losses incurred are as great. After bearing losses in percentages, leverage ends up costing a lot more damage than you actually bargained for since it entails playing with more money. For example, a 0.1 percent loss on a twenty thousand dollar trade using the 100:1 on each trade cost more than you can imagine.
Leverages are seen as constant liabilities
Trading forex with leverages is considered a liability in that it entails the fulfillment of the principal cost of the leverage whether as a forex trader, you are facing a successful or failed transaction at the end of a trading day. The cost of the leverage or money borrowed must be met by a traders account and will be automatically withdrawn from the account. This situation means that as you enter into a trade position using a leverage, you bear a load of leverage as a liability since you have to meet its demands at the end of the transaction. Even though the end result of the transaction turns out to be unsuccessful, as a trader you still need to meet the requirements of the leverage.
In forex trading, every borrowed fund as leverages are paid back with a reasonable amount of interest. The leverage is calculated with respect to interest and applied to a daily trade transaction basics depending on the rate set by the brokerage firm. The cost of owning a leverage is in accordance with the high degree of leverage existing in the forex market transactions and the cost of a leverage is in accordance with how the exposures are held long-term.
In conclusion, while there are a lot of disadvantages that surrounds leverage, it is not advisable to scrape it off completely from your trading surface since it has proven to generate profits and returns alongside other important advantages.
Summary
In the reals scenes, forex trading leverage is considered a double-edged sword. When leverages are working in your favor, it is really working for you and generating a higher yield of profits but when it turns against you, it can cause great damage to your trade positions as well as your trading account in the space of seconds. Therefore care should be taken while trading forex with leverages.
