What is Leverage In Forex Trading?How to Manage it Effectively?

Introduction

In simple terms, leverage is defined as the amount of money one can borrow at any given time against a given asset or a given currency. The more leveraged a trader is the higher his risk profile. Leverage also represents the ability to gain profit without the necessary investment on your part. However, if you have a good Forex strategy and a substantial amount of capital, there are high chances that you will be able to make big bucks even in small-scale trading like micro trading.

Basically, in forex trading, leverage refers to a particular currency’s capacity to obtain a certain level of performance above other currencies. It means that if you apply some amount of money and use proper leverage in forex markets, you will be able to earn much more profits compared to the value of the currency itself. Leverage has become one of the critical factors that help traders make more.

This leverage enables traders to make high-quality trades in the market at very low prices. However, there are some disadvantages as well. One of them is that it may cause volatility and losses. If you are a high-leverage trader, the market forces your price down to acceptable levels and eventually may get out of control. In other words, extreme leverage can lead to disaster. The ideal situation would be to maintain leverage levels but do not go beyond that level.

Therefore, traders generally opt for trading with leverage in the interbank market. This can be done in two ways – direct or indirect. Direct forex trading involves a person trading directly on his/her behalf. Indirect trading entails getting into a deal with another trader using an intermediary like a broker. These types of trading have their advantages and disadvantages, which we shall discuss in detail below.

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Indirect leverage is less risk than Direct Forex Trading

Direct trading involves a high-risk level since dealing with the counterparty directly. One significant advantage is that the price level will be determined by the real-time market data and nothing else. You don’t have to worry about the market’s internal functioning because the trader controls everything. As such, you can be sure that you will get the correct price information without having to wait for any announcements or statements from the central bank. However, this type of leverage is not recommended if you don’t have complete confidence in the market data.

Indirect leverage is less risky than direct forex trading but can still be quite expensive. Here, you will have to pay commission to a brokerage firm per trade, which may range from a few dollars to a few thousand dollars. This means that the trader will pay for the trades himself/herself and the brokerage fee. This type of leverage can reduce your profits, depending on how volatile the market is, and can sometimes even lead to the trader losing his money because of market inefficiencies. If used correctly, there is no downside to indirect leverage.

Forex traders use various types of leverage, depending on the forex market’s situation at a particular moment. Some traders tend to stick to the traditional ‘buy and hold strategy, meaning that they do not trade very often and thus do not require much leverage. Other traders like to make a quick profit from small profit moves in the market; they therefore apply large leverage. There are also some traders who believe that it is not important how much leverage a trader applies. What is more important is how he/she uses that leverage. These types of forex traders prefer to use both kinds of leverage, and are often known as swing traders.

Conclusion

Before you decide to start forex trading, you need to learn all about leverage. Once you know how leverage works, then you will be able to evaluate whether or not you want to take up forex trading. The leverage in forex trading can make a big difference in the amount you can earn. However, it is not always the best tool in the hands of the seasoned trader. In fact, you should always analyze the situation before deciding how much leverage to apply.

 

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