What is Leverage in Forex trading?
Leverage is an integral part of most Forex trades. It can significantly affect your potential gains and losses.
Leveraged trade example
For example, if you invest $50 and leverage 200 times, you could open a position in the market with a $10,000 face value.
- Margin: $50
- Leverage: 200
- Actual trade value: $10,000
If your trade increases 0.5% in value, from $10,000 to $10,050, and you decide to sell, your $50 profit will double your margin, netting a 100% return on your investment. In practice, leverage has increased your return 200 times from 0.5% to 100%. You could stand to earn far more if your trade rises further in value.
However, if your trade loses 0.5% of its value, moving from $10,000 to $9,950, and you decide to sell, your $50 loss will wipe out your margin in its entirety. You could stand to loose more if the markets move against you; unless your broker offers negative balance protection like FxPro.
How much leverage do I need?
The amount of leverage you are comfortable with will ultimately depend on your appetite for risk. If you are keen to mitigate your risk exposure, we suggest:
- Make a large initial deposit. The larger your deposit, the more you can reduce your reliance on leverage. Some brokers offer accounts with initial deposits as low as $5 with leverage up to 500 and higher; however, it may not be in your best interest to invest such a small amount. From experience, we suggest depositing upwards of $500 when you open an account. This should only be money that you can afford to lose.
- Choose flexible leverage. If possible, open an account with a broker that offers flexible leverage on a trade-by-trade basis. This will allow you to adjust leverage up or down depending on your appetite for risk and the trade's own merits.
- Negative balance protection. As the previous example has shown, leverage can increase your potential losses. If you are worried about loosing more money than you have invested, we suggest opening an account with a broker that offers negative balance protection.
- Risk management strategies. Ensure you have a risk management strategy in place before you trade. For example, stop loss orders can cut your losses yet provide upside exposure. Check our guide to Forex order types if you are new to Forex trading.