If you have been at all exposed to the world of Forex, you have probably heard the word “Leverage” being tossed around. But what exactly is “Leverage”?
Leverage is a very important part of Forex trading, and it is critical that you know exactly how it works and how to use it. It is the term Forex traders use to refer to the ratio of invested amount relative to the trade’s actual value.
Forex brokers usually allow their customers to trade with only a small percentage of the position value in their accounts, so that traders do not have to invest tens of thousands of dollars for the chance to make any real profit. When you trade at a leverage of 400:1 (or “400 to 1”), it means that for every $1 that you invest in the market, the broker effectively invests $400 for you. As a result, by investing $500 you can control trades worth up to $200,000.
As with any investment opportunity, with greater profit potential comes greater risk. Therefore, with higher leverage, your profit opportunity increases but you can also lose your funds more quickly.
For example, if you trade with 100:1 leverage, the market would need to move 100 pips against you for you to incur the same losses a 25 pip move against you would incur at 400:1 leverage. But at Alite Capital Markets, your losses are limited. Once the trade is no longer covered by your investment – that is, the “Free Margin” in MetaTrader reaches zero – the trade is automatically closed.
On the reverse side, if you trade with 100:1 leverage, the market would need to move 100 pips in your favor for you to realize the same profit a 25 pip move in your favor if you trade at 400:1 leverage. The advantage of trading with Leverage is that your profit potential is virtually infinite, and you have more control: you can always choose to trade a smaller position size if you wish to have lower risk.
Remember, Leverage can be a trader’s best friend when used carefully, and his worst enemy when used recklessly. It is a great tool for increasing profits; in fact private traders rarely trade without it. But you should always keep in mind that the higher the leverage, the higher the risk level.
Now that you are equipped with most of the basic tools, you can make your first trade!