How Does Leverage Work in The Forex Market

Understanding Leverage in Forex Trading – One guy said: “Sometimes it could go as high as 200:1. The regular is 50:1. Meaning, your trades would have a value 50 times what you have – magnifying its value. E.g $50 account = $2,500 trade. Due to this, you have the potential to double your money in a week – or lose all of them….

But, it would take an extremely undisciplined, unskilled trader along with a really bad luck to lose most of your money in less than a week. As long as you have a proper RISK and MONEY MANAGEMENT, you’ll do fine.”

Proper RISK and MONEY MANAGEMENT

As long as you have a proper RISK and MONEY MANAGEMENT,  you’ll do fine.”  That is like saying as long as you tie your parachute correctly there is no way you can get killed sky diving.

Trading is unlike a lot of other activities-you are always working in an environment of uncertainty.  You need to do certain things to keep the probabilities of winning on your side.

Using big leverage is too risky because 1 loss anywhere on your equity curve will put you so far back behind the 8 ball you will probably never recover.  You have to follow the models that the casinos have used successfully for 50 years.  Trade small and trade smart and even though you may lose here and there in the end you will make money consistently over time.

Leverage in Forex Trading

Yes, 50:1 leverage is not uncommon in spot forex trading.  Even 200:1 is easily achievable.  But leverage cuts both ways, so stop for a moment and think about what that means.

If you have a $1000 account, you are effectively being loaned another $50,000 to trade with (with 50x leverage).  This means you can take trades up to 50 times your normal position size.  Say you decided that rather than betting $2 per pip with your $1000 account, you would instead bet $100 per pip, taking advantage of your 50x leverage.  This means a 10 pip move in your favour would result in a (10 X 100) $1000 win.  You have now doubled your original account in one trade.  Well done.  However, by contrast a 10 pip move against you would wipe out your original $1000 account.  You are now broke (sad face).

If you were to let the trade run and it continued to move against you, you would be liable to repay $100 to the broker for every further pip it moved against you.  Meaning, you’ve not only wiped out your own account, but you now owe the broker money from wherever else you have it.

So, in a nutshell, leverage is a powerful tool that has to be treated with respect, and you need to have very strict risk controls in place and a sound position sizing methodology that will avoid you wiping out your account.  It’s also useful if you have a consistently profitable method of entering and exiting trades – in itself easier said than done in the highly efficient forex markets.

At the end of the day, the objective of investing is to stay in the game long enough to be there to fight another day.  And practise, persistence and patience are ultimately the keys to building wealth.