No matter what type of trader you are – beginner or professional – you already know what is leverage and how it can help you make quite a nice profit when trading Forex.
The issue is that you often have a wide range of available leverage rates because of the numerous brokers out there. As such, the question is – what’s the best leverage in Forex trading or how much leverage is right for me?
While most traders would advise you to register with a high leverage broker, it’s highly recommended to understand why a certain leverage ratio is preferred against a very low or very high one.
The Basics of Leverage
In short, leverage is trading power that is offered to you by the broker that you choose. It allows you to engage in highly profitable trades that you couldn’t experience with your current funds.
For example, a leverage of 50 to 1 means that for every $1 that you invest, the broker backs you up with $50 to increase your trading power and control more of a certain currency.
Naturally, keep in mind that leverage increases both trading power and trading losses. It goes without saying that they come with risks for beginner traders.
High Leverage and Risks
Nowadays, due to certain regulations, one common high leverage rate is the one mentioned above – 50:1. This implies that, for every $100 that you invest in your trading account, you have the possibility to control $5000 worth in currency.
As already mentioned, this allows traders to enjoy profits possible only with $5k investments – which are significantly larger than those worth $100.
For example, a 10% increase in a $100 trade is only $10 – whereas the same increase in a $5k trade is $500. However, this is reflected in losses as well. Due to high leverage, pip movement costs more. For example, 50 pips could end up with a loss of as much as 25% of one’s portfolio.
Low Leverage and Benefits
Low leverage provides the wealthy trader with more control over what they invest, lose, and win. For example, a 5:1 leverage means that every $100 investment allows them to control only $500 on the market.
Even though their trade options will be price-limited, they won’t experience drastic losses – as with high leverage. A 5:1 ratio paired with a movement of 50 pips would end up with the trade losing only 2.5% of one’s investment, compared to 25%.
Choosing the Appropriate Leverage
Believe it or not, traders don’t jump towards high leverage brokers. In fact, they’ve come up with rules that help both beginner and professional traders better manage the leverage they enjoy. As such:
- Low levels of leverage are usually recommended due to low and manageable risks.
- Capital protection and downside effect minimization are recommended, via the use of trailing stops. Such stops are essential to any trading strategy and shouldn’t be underestimated.
- When trading, each position should make use of up to a maximum of 2% of your total trading portfolio. As the old saying goes: never put all of your eggs in one basket. If the basket fails, you’ll be left with nothing!
Using the three rules above, beginner or conservative traders should feel extremely comfortable in the 5:1/10:1 leverage range. This range minimizes the risks but also provides them with enough trading power to engage in important trades.
The Importance of Trailing Stops
Depending on what leverage you trade with, you might find trailing stops more or less useful. However, the consensus is that they’re the best way to minimize losses when trading – for both beginner and professional traders.
But this is not everything they are capable of. Trailing stops also provide traders with some much-needed breathing time. If you employ a trailing stop, you can unglue your eyes from the screen or the trading interface and have faith that the stops will prevent you from losing too much money.
No matter the leverage, one should rely on trailing stops to improve their trading experience!
The Bottom Line
In the end, leverage is somehow directly proportional to experience, so to speak. If you have what it takes to engage in trades worth half a million dollars, but you lack the capital, then high leverage might be suitable for you.
On the contrary, if you want to minimize losses, trade carefully, gain experience while enjoying increased trading power, then you should stick with either low or medium leverage.
All types of leverage come with both advantages and disadvantages – it’s important to keep this in mind. High leverage can award you with increased profits, as well as with increased losses (unfortunately). Low leverage, on the other hand, minimizes your losses, but doesn’t make you rich overnight and in just a couple of trades.
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