- What is leverage?
- Why do you use leverage in trading forex?
- How to calculate the margin?
- How to restrict the risk of leverage when trading?
One of the reasons that many people are attracted to the forex market compared to other financial instruments is leverage. Because with forex, you can often use leverage much higher than other financial transactions like stocks.
What is leverage?
Leverage is to allow you to make a transaction that has a much larger value than your existing trading account, in order to gain substantial profits from the small movement of the price.
Why do you use leverage in trading forex?
The forex market often has a daily price change rate of just about 1%, this level of intersection is relatively small compared to the stock market. This is the reason the forex market allows to make trading with high leverage because when have small change in price can bring a significant amount of money.
For example :
Trader A and trader B both use $10,000 in their accounts to trade.
Trader A uses leverage is 1:50, raising the amount to trade to $500,000.
Trader B only uses leverage is 1:5 and the amount he can trade is $50,000.
Case 1: Each trader earns 100 pips
- Trader A with leverage 1:50 earned a profit of $5000, which is equivalent to 50% in just one trade.
- Trader B only earned $500, which is equivalent to 5% of the account.
Case 2: Everyone has a 100 pip loss, what will happen?
If the same 100pips loss, what will happen?
- Trader A will lose substantially $5000, equivalent to half of the account in an order ;
- Trader B only loss $500.
By using reasonable leverage, trader B continues to trade and can earn profits from profitable trades in the future.
Otherwise, Trader A can "fire" the account if the next order is lost.
How to calculate the used margin?
When you open an order, it is very important to ensure that you have enough money in your account to open and hold this order. Margin is calculated differently with different trading instruments. At FXCE, the margin is calculated according to the leverage you are using.
Margin depends on leverage:
Formula: Used Margin = Volume x Contract Volume * Exchange rate / Leverage
- You trade 2 lots of EURUSD, set leverage of 1: 1000 and exchange rate of EURUSD 1,11986
- Used Margin = 2 * 100,000 * 1,11986 / 1000 = 223.97 USD
How to restrict the risk of leverage when trading?
In order to restrict risk & increase profits when using leverage, each trader will have different ways when they are investing. However, here are some things which any trader should be aware of when trading:
- Use low leverage. Traders should maintain the leverage they feel most comfortable. If you do not like the risk or are practicing trading, you can choose a low leverage range of 1:5 or 1:10.
- Use trailing-stop to restrict risk and better capital preservation. Trailing stop helps investors feel more confident and reduce losses when the market goes against the original prediction.
- Always set a stop-loss limit of 1% to 2% of the total account for each order.
Leverage only works to help you increase trading volume. When you do not make profits and lose capital, then the amount of money will disappear gradually based on the number of Pips and Points that the market fluctuates, until your original capital in trading is no longer available. When you understand clearly how forex leverage works, you will take advantage of it while still avoiding big risks. Leverage can be used successfully and profitably if properly managed.