LEVERAGE INTRODUCTION – Let’s figure out what is the best leverage level for a beginner. Many newbies are attracted to the leverage-based earning strategy as they want to make more money in a short period of time.
However, remember that leverage is associated with certain risks. You need to at least understand the concepts that are directly related to money management in leveraged trading, such as:
- Balance and Equity of your account;
- Free margin;
- Account Level;
- Margin Call and Stop Out.
Benefits of leverage use
First, let’s take a look at the benefits of leverage for a novice trader:
1. Chance of making super high profits
Using leverage on Forex gives traders the opportunity to increase their initial investment in order to play big.
Best leverage ratio example
For example, a trader who has only 1 thousand dollars on their account can actually trade on the Forex market with 50 thousand dollars with a leverage of 1:50 or 100 thousand dollars using a leverage of 1:100. Simply put, this trader risks losing 1,000 dollars of their own funds, but if successful, will receive a profit of $100,000 if the position was opened at 100% margin and the leverage 1:100.
2. Improving capital efficiency
For example, if your account balance is $1000 and you use a leverage of 1:100, you will in fact have 100,000 USD to manage. This means you have the opportunity to open more trades in various trading instruments and apply hedging techniques for additional protection against risks .This allows you to diversify your portfolio, reduce risks, and increase the chances of making a profit.
3. Low entry level
Let’s look at this advantage using the previous example – you have 1,000 dollars on your account. Let’s say that you don’t use leverage, i.e. you trade 1:1.
Under these conditions, at best, you will be able to open one position with a minimum lot of 0.01, and not even on the EUR/USD pair.
This is because on Forex one lot is usually 100,000 currency units. In other words, to open a minimum position in one of the most traded pairs on the Forex market – EURUSD – you need 100,000 * 0.01 * 1.17470 = 1,174.70 USD.
With 1,000 dollars on your account and no leverage, you will not have the opportunity to open even such a small position. However, thanks to the large leverage, even people with a small deposit of 50-100 dollars have a chance to access the art of trading and trade on a par with professionals.
4. Favorable financial conditions
Before, when brokers provided no leverage, the only opportunity to trade with leverage was borrowing a very limited amount of funds from the Bank at high-interest rates, huge collaterals and guarantees.
In the face of serious competition, Forex brokers provide large leverage to attract clients with a very small amount of the deposit and with minimal commissions. If you trade intraday, using leverage will be almost free. If you decide to carry the trade overnight, take SWAP into account – it’s the broker’s overnight commission.
The deposit growth of the high risk traders can easily reach up to 300-500% profitability per month, which is much higher than in any bank.
It is important to understand that the main income of a decent broker comes from the commissions for opening trades, SWAPs and spreads. Therefore, it is very important for a broker that each client uses their services as long as possible, achieves success in trading and becomes rich. A decent broker does not need you to drain your entire deposit and swear to never trade on Forex again.
Therefore, in a highly competitive environment, Forex brokers provide an opportunity to choose leverage on favorable terms at low interest rates, a flexible tariff schedule, and minimal commissions. Often reputable brokers even offer the personal manager services. A personal manager will help you understand all the nuances, choose the optimal leverage and balance your trading strategy.
You’ve probably heard about Margin Call. Many traders are scared breathless of these two words. But in fact, this function is designed to protect your deposit. Unfortunately, it often happens that novice traders misjudge their risks. When it becomes obvious to the broker that the chance of you losing your deposit is high, they call or send you an auto-message about the need to replenish your balance to cover high risks.
Sometimes negligent traders forget about leverage and the obligations associated with it. As a result of unreasonable trading, they can turn into the debtors of the company. To avoid this, use the services of brokers that guarantee zero balance in case of liquidation of trade. Thanks to this feature, you will never lose more than what you have on your balance.
WHAT IS THE BEST LEVERAGE FOR YOU?
So, what’s left for beginners who are advised to use a 1:10 leverage but don’t have $10,000 and want to trade successfully, making money now?
- Decide on your trading style. Are you going to actively trade intraday or catch medium-term trends? Or maybe you would like to collect a portfolio and forget about it for a while? I hope that it is clear from the material described above – the longer the horizon of trades, the larger size of the deposit is needed.
- It is very important to study theory and the market in which you are going to trade. You absolutely need to master basic technical analysis. Understand the specifics of the market – news, reports, multipliers, indicators and other factors that can influence the price of your favorite instrument.
- Trade only with the money you are mentally ready to lose. It may sound old-fashioned but it’s true! Following this rule, you will relieve yourself of unnecessary stress and trade with calm confidence.
- Feel free to seek advice from more experienced colleagues. It’s okay to ask questions, but it’s important to do it right. Try to ask closed-ended questions with a yes-or-no answer. Such questions require preparation and effort, which will give you the right answer in 80% of cases.
- If you realize you cannot spend enough time for active trading but you want to invest, the solution can be in social trading, where you copy other experienced traders . Choosing a real professional is an entire science and I would need a separate article for this. But do not trust the entire deposit to one manager. Share risks between different traders.
- Do not use the entire margin for one trade. Better to have 100 different positions with a minimum lot of 0.01 than one trade with a lot size of 1.
- Remember to use stop loss! Do not allow the loss on one position to exceed 2% of the deposit.
- Don’t stop perfecting your risk management system. Determine the maximum allowable risk for the amount of open positions. Monitor compliance with the risks for each position. Keep track of the account level. Avoid stop out.
- Do not open a position without a predetermined trading plan. Identify the entry-level, take profit and stop loss, the signal for increasing the position and the signal for exiting the market.
- Keep a trader’s journal! Write down trade parameters, entry and exit signals, even the emotional state when entering and exiting the market. Keeping a journal will make trading more mindful and provide a basis for introspection and learning from your own mistakes.
Overall best leverage for Forex with Examples
As we have seen, the best leverage ratio on Forex is a relative term. In addition, this tool must be used with care. Using too high a leverage can either bring incredible profits or ruin the trader.
The best leverage for Forex trading depends on the capital at the trader’s disposal. It is believed that a ratio of 1:100 to 1:200 is the best leverage for Forex. In this case, a trader can get tangible benefits from margin trading, provided correct risk management. A leverage of 1:100 means that with $500 in the account, a trader can open trades with a total volume of $50,000, which is the optimal amount to start trading on the foreign exchange market. At the same time, it is vitally important to follow your own risk management rules, not to abuse free margin and always keep a reserve of funds for potential closing of all open positions by stop loss in order to avoid early liquidation of active trades.
Leverage is a progressive tool for traders to achieve good results. The obvious advantage of using leverage is that you can make a lot of money with only a limited amount of capital. However, it is impossible to choose the best leverage to use in Forex for both beginners and professional participants. This choice largely depends on the starting balance, trading strategy and the chosen risk management model. At the same time, the best Forex leverage is considered to be 1:100. This is a compromise between sufficient purchasing power and the risks of automatic liquidation of positions by Stop Out. This leverage ratio is favored by both beginners and experienced traders. However, one should always remember about the risks that high leverage carries.