Leverage As Part Of Your Forex Training
Leverage has been one of the key reasons for the popularity of forex over the years. Forex trading offers high leverage and for an initial margin requirement, it is possible for a trader to accumulate and manage a massive amount of funds. The ins and outs of leverage should be covered during your forex training period to ensure that you are fully aware of the advantages and disadvantages of this facility.
To calculate margin-based leverage, you should divide the transaction total amount by the level of margin you are meant to provide. An example is if your margin is meant to be 1% of your total transaction value, and you intend trading a standard lot of USD/JPY. This lot will cost you $100000 which means the required margin is $1000. This implies that your margin-based leverage ratio is 100:1. If your margin requirement was 0.25%, your leverage ratio would be at 400:1.
Margin-based leverage does not affect your risk because your margin requirement may not have any influence whatsoever on your profit or loss. This is because you have the option to allocate more than the required margin for any trade. You should have a look at what your real leverage, not your margin-based leverage, is.
Real Leverage and Forex Training
To arrive at the value of real leverage, you should divide the face value total of your open positions by the amount of trading capital. An example is if you have a total of $10000 as the balance in your trading account. If you start a $100,000 position which is one standard lot, you will effectively be trading with 10 times leverage. If you decide to trade two standard lots and you have $10,000 in your trading account, then the leverage has increased to 20 times.
This means that the margin-based leverage is equal to the maximum amount of real leverage that you can use as a trader. The majority of traders do not use their full account balances as margin for every trade they do, so their real leverage is very different to their margin-based leverage.
Risks Of Real Leverage
It is possible for you to amplify your profit or loss by the same level when you use real leverage. The higher the level of leverage, the higher your risk exposure tends to be. This risk is often not related to instances of margin-based leverage, but it may influence your trades if you do not take care.
An example of this is two traders A and B who both have trading capital of $10,000 each. Their brokers require a margin deposit of 1%. Once they have undertaken analysis, they agree that the USD/JPY currency pair has reached its pinnacle and will fall soon. So they both short the currency pair at 120.
Trader A opts for the use of 50 times real leverage by shorting $500,000 of the currency pair. Since the currency pair currently stands at 120, one pip for a standard lot will be worth about $8.30, so for five lots it will be worth around $41.5. If the pair climbs to 1.21, Trader Z could lose 100 pips on that trade which will equate to a loss of $4150. This loss is representative of a huge 41.5% of his trading capital.
Trader B was more careful and opted to put 5 times real leverage on the trade by going short on $50,000 of the pair. That is only half a standard lot. If the pair rose to 1.21, Trader B would lose 100 pips which would equate to $415. This is representative of only 4.15% of his capital.
Get to grips with leverage through your forex training if you want to be a successful and profitable forex trader.