How to Choose the Right Forex Leverage?

Leverage in Forex Trading

Leveraged trading is a common strategy in the Forex market as it offers one of the highest amounts of leverage available to traders. Forex leverage enables traders to borrow funds from their brokerage to open bigger trading positions, thereby increasing their chances of profitability.

In Forex, leveraged trading can also be called margin trading, as the margin is the amount of money needed as a good faith deposit in order to open a new trade with your account. The $1000 in your 1:1000 leverage account is your margin. Margin requirements may vary depending on the size of your trade.

How to Choose the Right Forex Leverage？

Forex traders use different leverage levels based on their trading strategies and their ability to anticipate market movements. Usually,short-term traderslike scalpers and day traders tend to trade with high leverage since they usually look for price changes within a short period. By contrast,long-term traderstypically use low levels of leverage.

Regardless of how attractive leverage may seem, you should always keep in mind that excessive leverage can wipe out your entire starting capital in a matter of seconds. Leverage is directly related to theequityof your forex trading account.

Lets assume you are trading a currency pair with $100 and you are not using leverage. You can achieve the following results:

• With an increase of $10, you get a profit of $10.

• If the trade falls by $10, you will suffer a loss of $10.

When you apply 1:100 leverage, you get different results:

• With an increase of $10, you get a profit of $100.

• If the trade falls by $10, you will suffer a loss of $100.

The greater your leverage, the more volatile your account equity will be. Likewise, lesser leverage means less volatile your account equity will be.

Example using High Leverage:

Let‘s say thatTrader Ahas a $10,000 cash account. He decides to use the leverage of 1:50, which means he can trade up to $500,000. In forex terms, that’s 5 standardlots.

In forex trading, there are three basic trade sizes: Standard lot (100,000 units of the quote currency), the Mini lot (10,000 units of the base currency), and Micro lot (1,000 units of quote currency). Price fluctuations are measured in pip movements, and the pip value depends on the lot size.

Assuming the trader purchased 5 standard lots in USD, a singlepipmovement would earn the trader $50. Likewise, if the trade fails, the trader loses 50 pips, i.e., 50 pips x $50 = $2,500. Thats 25% of the $10,000 account.

Example using Low Leverage:

Heres whatTrader Bdid. Instead of using the maximum leverage of 1:50, he used a conservative leverage ratio of 1:5. If Trader B has $10,000 in cash, they can trade $50,000 in currency. A mini-lot is equal to 10,000 units of currency, and each pip is worth $1. As Trader B has 5 mini lots, each pip movement could earn him $5.

In case the investment fell by the same amount, by 50 pips, then the trader would lose 50 pips x $5 = $250, which is just 2.5% of the total position.

Leverage adds excitement to forex trading. With leverage, Forex traders are able to gain greater access to the market than they could otherwise afford. However, while leverage increases gains, it also magnifies losses. So, choosing the right Forex leverage is important for long term trading success. If the trading losses erode the margin levels substantially, it can adversely affect their long-term trading careers.