Learn About Leverage Forex: The Double-Edged Sword

Learn About Leverage Forex: The Double-Edged Sword

Why are you interested in forex trading ? Is it because of the big opportunity? Two-way opportunity ? A stunning forex strategy ? Or is it that you really want to learn more about forex ?

Whatever your reason, it doesn’t matter. But clearly there is one factor that may not be found in trading other financial instruments: leverage .

How does leverage work?

In forex trading , the existence of leverage allows you to make transactions with capital that is far less than the real capital. For example, to make a contract size of $ 100,000 (one hundred thousand dollars), you can only spend capital of $ 1,000 (called margin ) with a leverage of 1: 100. The calculation is like this:

Required margin = Leverage x Transaction value

So, even if for example you only have $ 10,000, you can still make $ 100,000 transactions because the capital you need is only $ 1,000. Just 1% of the actual transaction value.

Now, if leverage changes to 1:50, that means you need a margin of $ 2,000 to make a $ 100,000 transaction.

Leverage of 1: 100 is called “leverage margin.”

Real leverage

You must learn to understand real leverage in forex trading , because this is far more important than the leverage margin itself. To be able to find out real leverage, it’s actually quite easy. You only divide the total transaction value from the open positions that you have with the total capital you have.

For example: You have a capital of $ 10,000 in your account, then you open a position of 1 standard lot; worth of $ 100,000. Well, in these conditions, it means that you make a transaction with leverage 10 times greater than your capital (100,000 divided by 10,000). If you open a position of 2 standard lots (valued at $ 200,000), then your capital leverage is 20 times.

In forex trading , we constantly monitor price movements in units of pip. The movement of one pip can be the 5th or 3rd decimal movement of the price you monitor, depending on the pair’s currency, whether your forex strategy is applied. But apparently the pip movement is only a fraction of a cent. As an illustration, if you see a price move – for example EUR / USD – from 1.13000 to 1.14000 (as far as 1000 pips), the price actually only moves by 1 cent.

That is why to be able to get a more “fast” profit, you have to make large transactions so that the movement of each pip can have a significant effect. As mentioned above, the transaction value for 1 regular lot of forex is worth 100,000 dollars.

You really cannot determine the margin of leverage, because the exchange has determined the amount. What you can manage freely is real leverage, based on your trading style and trading plan, of course.

Risk is directly proportional to leverage

Real leverage has the potential to increase the profit you get from each pip movement, but at the same time it also has the potential to increase the losses that you might suffer. The greater leverage you use, the greater the risk that looms. Indeed this is not directly related to margin leverage, even so the amount of margin leverage can also cause the same thing.

Let’s look at the real leverage calculation first:

Say Trader A and Trader B both have a capital of $ 10,000 and open a sell transaction. Trader A opens a position of 5 standard lots, meaning $ 500,000. This means that it uses real leverage of 50 times greater than its capital. If he experiences a loss of 1000 pips (assuming 1 pip = $ 1), then that means he has a loss of $ 5,000. This loss means 50% of its initial capital.

Meanwhile, Trader B opens a position of 1 standard lot, meaning $ 10,000. In other words, real leverage applied is only 1 times the capital. If Trader B also experiences a loss of 1000 pips (assuming 1 pip = $ 1), then that means he only loses $ 1,000; only 10% of the capital.

Auto cut

Now we see an example of a case by calculating the margin of leverage first.

Trader A uses a 1: 100 leverage margin, while Trader B uses a 1:50 leverage margin. Both of them open long positions for 1 standard lot.Thus, Trader A requires a transaction capital of $ 1,000 while Trader B requires $ 2,000.

Assume both suffer losses of 1000 pips, which means $ 1,000 (assuming 1 pip = $ 1). Thus, Trader A experiences a loss of 100% compared to its capital, while Trader B only loses 50% of its capital.

That’s just from the margin. We have been together that year in forex margin trading the name is the ” auto-cut” level. Your open position will be forcibly liquidated by the system if your losses are large enough to make your level margin less than or equal to 20%.

That means, if it turns out that Trader A is auto-cut, then the remaining funds left are only $ 200 (20% of the margin requirement). Meanwhile, even if Trader B experiences auto-cut, it still leaves capital of $ 400.

Conclusion

There are two types of leverage: leverage margins and real leverage. The impact of leverage margin is not very visible in risk management or capital management, but from the calculations presented in the example above, there is clearly a difference. With less leverage, your potential loss can be reduced.

Even more important is to pay attention to the real leverage you use.The greater the leverage, the greater the risk faced. By learning to understand leverage in forex , hopefully you can be more wise in managing your funds.

Congratulations on learning forex !

author
Forex4Live.com is a forex trading system website that started to be published since 2011 and has been used by thousands of traders around the world. The system is very simple and accurate, priced at $ 167 for a lifetime membership with no monthly fees or hidden fees. Our team created this system by testing thousands of indicators then selecting 23 indicators and combining them into one great trading system.
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