Understand the Risks Of Leveraged Investing Strategies Before Using Them
Understanding Forex Leverage
Leverage is an important feature of trading that can increase the expected profits manifold, if used correctly. With forex leverage, traders can get much larger exposure to the market than the amount they deposit in their forex mini account. Traders can trade financial products like CFDs that can magnify the potential profits or losses.
What is leveraged Trading?
Leveraged trading refers to opening a larger position with limited capital. The leverage offered by the high leverage brokers is represented in ratios that can be as small as 1:10 and as high as 1:3000. Traders can choose their preferred leverage based on their risk tolerance and trading skills.
For e.g., if the trader wants to use forex leverage of 1:100, it means that every $1 invested by the trader is worth $100. If the trader is trading one standard lot i.e., 100,000 units of the base currency, he’ll only need 1% of the 100,000 to initiate this trade i.e., $1000. Traders can open $100,000 worth of positions by using only $1000.
Margin is an important term that is used frequently in forex leverage. Margin is the minimum amount of money that is required to open and hold a trading position. In the above case, $1000 is the margin that is required to open the trade.
Though leveraged trading can be highly profitable, it can also magnify the risks if not done properly.
Benefits of Using Forex Leverage:
- Using leveraged trading, traders can amplify their potential profits with a relatively smaller amount of money.
- Traders can open multiple trading positions and diversify their trading portfolio.
Understanding The Risks of Using Forex Leverage:
Leveraged trading is considered a double-edged sword as it can amplify both potential losses and profits. Leverage can increase the potential losses as a slight movement in the price can influence the losses heavily. Sometimes the losses incurred by this can even jeopardize the whole trading portfolio. Therefore, it is important for traders to understand the risks and take necessary measures to mitigate the risk and limit potential losses.
Measures to Limit the Risks While Using Forex Leverage:
Leveraged trading is a highly risky trading strategy and traders should always apply strict risk management strategies to mitigate the risks involved in leveraged trades. Some of the risk management measures that can be used are:
- Use of stop-loss – Stop loss is a risk management tool available on the trading platform used to close the trade automatically when the market reaches a specific level. Stop-loss is designed to limit the risk involved in trading.
- Take Profit – The forex market is highly volatile. So it is better to place a take profit order. Take profit is a limit order that allows traders to close the position when the expected profit hits a specific amount.
- Understand your risk tolerance – Many traders trade with money that they cannot afford to lose. In forex, this is not a wise thing to do. Traders should always understand their risk appetite before choosing a particular leverage ratio.
- Risk-to-reward ratio – Calculate your risk to reward ratio and if the risks are more than the reward, avoid trading that trade.
Leveraged trading can magnify expected profits, however, it is a risky strategy to use if a trader is new to the market or does not have enough trading experience. Beginners should always start with a small leverage ratio. Leveraged trading can be highly profitable if the trader knows how to use forex leverage wisely.