Risky as it may be, there is some wisdom in using leverage and margin in your forex trading. These trading conditions, however, should only be used with extreme caution and with careful planning. The same huge gains that you are expecting with a highly leveraged trade could just as easily result in the same amount in losses for your trading account. With this in mind, you should carefully balance your expected profits with leverage and margin with the risks involved in every trade. The same trade can result in different losses or gains for two traders using a different leverage ratio.
Leverage and margin allows forex traders to trade in amounts that are higher than the capital in their trading account. Forex traders, in effect, are borrowing a certain amount in leverage to cover the rest of the trading capital required to trade certain lots. The forex broker takes care of the leverage while the forex trader is left to put up his share in margin. Although the leverage and margin do not influence the profitability of the trade, they do magnify the amount of gains or losses a forex trader experiences in his trades. The higher the leverage, the more the gains or losses will be magnified.
Leverage is usually indicated as a margin-based leverage or as real leverage. Margin-based leverage is the ratio of leverage to margin while real leverage is the number of times your trading capital is multiplied into your leveraged transaction value. Buying a standard lot of 100,000 currency units that will require 1,000 currency units in capital can be expressed as 100:1 in margin-based leverage or 10 times in real leverage.
The prospects are so appealing when forex traders think about how much more their yield potential can be increased by trading on leverage. Trading at a leverage of 50 times your capital or margin means that you can also multiply your gains by 50 times. Many have enjoyed gains on high leveraged trades, but most of these are carefully thought out trades. Newbie traders who are attracted to using leverage and margin can easily make a mistake in thinking that profitability in forex trading means that every trade has to be a highly leveraged trade. This is perhaps one of the fastest ways by which beginner forex traders can be wiped out of the forex trading arena.
Making leverage and margin part of your forex trading plan is the best way for you to manage your risks and maximize your yield potential in your trades. It’s all about carefully weighing your risk-return scenario and your trading capital – how much of your trading capital are you willing to risk in case a trade does not pan out as you expected? With a carefully executed forex trading plan, a leveraged account can bring you more profits than your trading capital can bring you on its own. In most cases, a moderately leveraged trading account brings much more manageable risks and allows the forex trader to get right back into trading when he loses out on his trade.