Not only is the forex market one of the largest entities of its type anywhere in the world, but it’s also deceptively complex and incredibly volatile.
This means that traders must get to grips with the market’s unique factors and terminology before they begin to trade for real, and this process should start by understanding the role that leverage plays in currency trading.
We’ll explore this below, while asking how this impacts on your trading experience and potential returns over time.
What is Leverage?
The term leverage is widely used in forex trading, with this referring to the use of borrowed funds to increase the size of an individual trading position.
This is beyond what would be available from their cash balance alone, with the associated term ‘margin’ used to describe the amount of debt borrowed from a forex broker.
Typically, leverage is expressed as a ratio, which describes the value of a potential trade in relation to your initial deposit. So, if a broker is offering leverage of 50:1, this means that you can trade up to $50,000 in value for every $1,000 in your trading account.
In the forex market, the maximum leverage is usually expressed as 100:1, which would equate to a $100,000 trade value in relation to a $1,000 deposit. However, this will vary from one brokerage firm to another, while the terms of your no deposit bonus forex offer will also differ in some instances.
What are the Advantages of Leverage in Forex Trading?
As we can see, the most obvious advantage of leverage is that it enables you to open and control large trading positions with a minimal deposit.
This is largely possible because leverage serves as a function of risk in the volatile forex market, while it also paves the way for potentially huge and disproportionate gains.
Another advantage of leverage is that it provides improved capital efficiency, as you’ll have the opportunity to open more trades across a wide array of markets and different trading instruments. This allows for improved hedging techniques, which can minimise risk and stretch your capital further over time.
Leverage also offers you a lower entry level, which makes the market considerably more accessible to part-time or novice traders.
Of course, there’s a significant risk associated with inflated leverage, as the margin-based nature of currency trades means that you could also lose considerably more than your initial deposit.
How Can You Minimise This Risk?
Fortunately, there are direct steps that you can take to minimise leverage-associated risks, such as implementing careful money management measures.
This includes only ever investing capital that you can afford to lose, while also ensuring that you distribute your wealth according to your portfolio and range of assets.
Similarly, we’d recommend imposing so-called “stop losses” on your forex trading account, which seek to automatically close positions once they’ve incurred a predetermined level of loss.
This can prove to be worth its weight in gold, particularly if you trade international currencies and during periods that are outside of your waking hours.