Understand Leverage Trading: A Beginner’s Guide
Introduction
In online forex trading, margin and leverage are terms that are familiar to everyone who has ever dabbled in the financial markets, especially trading and investing. They are essential components of margin trading and are interdependent on one another. Let’s take a look at what leverage trading is, as well as the many other strategies and tactics that may be employed in conjunction with it.
Leverage in Forex Market Trading
In the realm of finance, leverage refers to the practice of leveraging debt or borrowed funds to take a position in a financial instrument. This may be executed in a number of different ways. There is a substantial potential for gain when one borrows money with the intention of profiting from a financial instrument; yet, this strategy is not without risk. In addition, the fact that the trader is using borrowed money magnifies not just the potential rewards but also the potential losses.
When day trading forex, cryptocurrency, commodities, or any other trading instruments, the term “trading leverage” is most typically used to denote the use of borrowed cash to increase the size of position sizes. This is something that you have borrowed from the broker, and just like any other loan, you will be charged interest on it. However, more advanced forex trading platforms do all of these calculations “behind the curtain,” leaving the trader with nothing more than the task of trading to worry about.
A daily interest rate that is based on an annual percentage rate is used to compute the cost of this loan’s financing. This translates into a relatively small commission charge for the majority of traders for any position. The amount of interest that is involved has very little of an impact on the result unless you intend on “purchasing and keeping” the asset.
Unleveraged vs Leveraged Forex
Unleveraged forex
You want to acquire $10,000 in USD/CHF. Without a margin, you must open with the whole $10,000.
Profit
The Swiss Franc appreciates against the US Dollar, and you sell your investment for $10,100, yielding a profit of $100.
You have generated a 1% profit of $100 from $10,000.
Loss
And if the pair’s price dropped to $9,900, you would again incur a $100 loss, which corresponds to a 1% loss since your initial investment was $10,000.
Forex with a margin of 5%
If you want to purchase $10,000 worth of USD/CHF with a 5% margin, you need just $500 to initiate a position.
Profit
The Swiss Franc appreciates against the US dollar, allowing you to sell your investment for $10,100 and generate a profit of $100.
You have earned a 20% profit on $500, or $100.
Loss
What if, however, the Swiss Franc declined, and you sold your stake for $9,900? You’d lose $100, or a 20% loss.
The above illustration demonstrates that using leverage will result in a multiplication of not only your earnings but also your losses. When utilizing leverage, it is very necessary to include the execution of orders as an integral component of a complete risk management strategy. In the course on strategies and risks, we will go over this topic in more depth.
Trading CFDs with Leverage
In CFD trading, traders can also use financial leverage to start with less money. CFD can be used for stocks, commodities, and cryptocurrencies, among other things.
Let’s say Stock 1 is there. It is being sold for $5.00 right now. A trader wants to buy 10,000 Stock 1 contracts. A 10% margin is given by a broker. This means that the trader only needs $5,000 to buy 10,000 contracts of Stock 1 (10% of $5 per contract times 10,000 contracts).
If the trader didn’t use CFD and bought the stocks on the cash market, the price would skyrocket to $50,000 ($5 times $10,000).
Advantages of Leverage
In forex market trading, traders of all skill levels often use leverage trading because it is widely available and very easy to use. In fact, it is also a very clear instrument that has clear benefits like:
- Increased capital for the transaction, allowing you to build large positions with modest cash.
- Leverage in trading enables traders to magnify their earnings on successful deals. Instead of margin, profits are obtained from a managed trading position. As a consequence, traders may generate substantial returns despite slight fluctuations in the underlying asset values. However, keep in mind that leverage increases both possible earnings and losses.
- Price fluctuations are predictable since they often occur in cycles of high and low volatility. Traders have the ability to earn substantial gains during times of low volatility. Small price variations might potentially result in substantial losses.
- Traders may join capital-intensive markets even if they have little personal money.
Takeaway
Leverage is a very powerful tool that lets you make more money and trade forex successfully even if you don’t have a lot of money in your account. But, like any other powerful tool, it should be used with care. If not, a trader can lose a lot of money. A new trader shouldn’t start with high leverage and try to make a lot of money right away. Use a leverage of 1:2-1:30 as long as your capital is low. If you don’t, you will lose everything in your account if you fail. Set stop loss orders and work to reduce your risks. Make a plan and come up with a strategy. Don’t worry about your first losses, and keep working in this field to learn more.
