Particularly if you are new to forex trading, you may have asked yourself the question, what is leverage in forex? As you see the term being used a lot.
Here we will explain exactly what it is, how it works, and how you should approach it especially if you have signed up with a High Leverage Forex Brokers to help yourself balance risk and reward.
Let’s take a closer look.
Table of contents
What is leverage in forex?
Leverage in forex at its core is essentially borrowing money to invest based on the balance you have in your brokerage account. This money typically comes from the broker and allows you the ability to open an increased size of a position and amplify your holdings without risking all of your own capital.
Naturally, opening these bigger positions will subject you to larger gains but also has the potential to amplify your losses as well. For this reason, it is important you know exactly how to utilize your leverage in a safe way alongside a solid risk management system.
How does forex leverage work?
Forex leverage works with the broker essentially covering the remaining size of a position you wish to open, while you invest a certain amount. There are a couple of things the broker may require since opening a position using leverage is essentially loaning money from them.
They may want an overnight commission if you intend on keeping the position open overnight which in itself would generate overnight fees. They will also set margin limits to ensure the balance of your account remains positive. If the position moves against you then this could lead to a margin call where you are required to deposit more or close the position.
Forex Leverage: What is the broker’s role?
The role of the broker in forex leverage is central. They are the entity that is lending you the money to trade on leverage with. Now, how much leverage you can access will depend on the maximum available leverage the broker makes available, and the leverage ratio that you choose.
A very important thing to do is to make sure you are always trading with a regulated broker. Unregulated brokers may well make very high leverage available but this can come with huge risks. Regulated brokers on the other hand will be required to follow strict rules on the amount of leverage they can offer, particularly for traders in the UK, EU, and Australia to non-professional traders. These restrictions are only in place for your total protection.
Pick your leverage on Forex
Of course, the decision on choosing the amount of leverage you need will be up to you, providing it is within the maximum leverage made available by your broker. This does not mean you should automatically choose the highest leverage though. You need to take into consideration many factors including your trading strategy and goals.
You will also want to consider how long you will hold the position. The general rule is that the longer you plan to hold the position, the lower the leverage should be. Scalping is a good example of when traders take advantage of high leverage since they try to exploit very small movements in a short period of time.
For more on scalping forex effectively, you can have a read of our guide on how to scalp forex without getting burned.
Manage risks with leveraged trading
As mentioned, good risk management is essential in using forex leverage since it can multiply either your profits or your losses. As a result, you will need to have a well-planned strategy in place to help you manage these risks. The best way to do this is by starting out using only a small amount of leverage. This can allow you to learn and see the impact of leverage.
You should also use the other tools at your disposal like stop-loss orders to prevent any of your positions from running out of control, while a diversified portfolio is also important to ensure you are not overly reliant on just one position for all your funds.
What is leverage in forex FAQs
What is the best leverage to use in forex?
This will really depend on your own situation. As a guide though, it is best to start small. On positions you plan to hold for longer periods this is also the case. You may also find that your leverage access is limited depending on your location, so this should serve as an additional indicator.
What is a 1:500 Leverage?
1:500 leverage means you can borrow up to 500 times the amount of your own capital from the broker. For every $1 you have in your account, you will have $500 available to trade with. This is typically very high risk and not recommended in regard to your risk management.
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