Using leveraged trading for your FOREX operations can be very profitable. However, what can make you can also un-make you, and this is no exception. While trading with leverage has helped out many traders (and it continues to do so as we speak), it has also been the cause of significant loses for others. The main reason for that is not knowing how to choose the right leverage. And we’re here to teach you how to do so.
But, the first thing you need to know is what’s leveraged trading.
Now, “leverage” isn’t exclusive to FOREX. The term means using money from a third party to increase the capital available for investment.
Usually, that means taking on debt. However, FOREX brokers usually offer you the possibility for leverage without you having to pay back the credit. The only condition is that you don’t go below your minimum investment.
So, trading with leverage means trading higher values than what you could normally afford with help from your broker. Understanding that is the first step to choose the correct level of leverage for your transactions.
Why Do You Need To Be Careful With Your Leverage?
When people research this trading tool, the mindset they acquire is “leverage lets me win more money”, and that’s it.
Needless to say, making such shallow conclusions about any concept is a dangerous thing to do when it comes to trusting your money to it.
That’s because, while you don’t need to pay any credit when using leverage, it is your money that’s being used as collateral. In other words, the broker will help you out with your purchases, but they won’t replenish any of your losses.
If you use leverage, your trading volumes will be inflated, and that means two things:
- Your profits will match your leverage instead of your base capital. As such, they’ll be higher.
- Your losses will also go along your leverage and not your own capital. So, they’ll be higher as well.
As you can see, you have some sort of balance when it comes to leverage in that it raises both possibilities in a trade.
In other words, by using a leverage of 1:50 (for example), you have three conditions:
- You’ll be able to invest $50 per each $1 invested.
- You’ll win $50 where you would’ve won $1.
- You’ll lose $50 where you would’ve lost $1.
And those loses quickly escalate when you factor in losing streaks and higher values (instead of losing $10, you lose $500).
What Is Necessary To Ensure The Correct Leverage Is Used?
Using the correct leverage means that the profit/loss ratio is stable. In other words, trading with leverage in a correct way means that you can increase your profits without risking too much of your money.
It may be easy to go and say “just don’t use leverage”, but the truth is that this is a very profitable tool.
So, the correct approach is using it wisely. And, to do so, you need to keep several things in mind.
- Don’t Leave Out Your Stop-Loss Orders.
Stop-loss orders are your safety mattress.
Not only you should be using them all the time, but you should pay extra attention to them when trading higher volumes (and leveraged trading brings higher volumes).
Not only will they prevent you from losing too much, but they’ll also keep you learning how to use leverage in FOREX trading without risking it all.
They ensure a safer learning process.
- Be Realistic.
There are many brokers advertising leverages from 1:50 to 1:1,000. Some even offer unlimited leverage!
Before reaching for that leveraged trading option, stop and think about how much leverage you really need to earn a significant profit. There’s no need to use a 1:500 leverage when 1:10 will yield enough.
There’s a reason why expert traders use the smallest leverages they can.
- Calculate As Precisely As You Can.
This will also help you not overdo it when using leverage.
Try to predict how much you’ll need before trading with leverage. And, when you do so, try to get as close as possible.
This way, you’ll avoid using risking more than what you really need.
- If You’re Still Not Sure, Keep Your Leverage To A Minimum.
The bottom line here is, never use too much leverage.
While you should definitely strive to take advantage of this possibility, the real answer to the question of how much leverage should you use is “what you feel comfortable with”.
And, if you don’t feel comfortable with leveraged trading, or you’re barely starting out, the second answer is “as little as possible”.