Forex Trading Strategies: Leveraged Trading

Most brokers these days advertise leverage as one of the selling points of opening an account with them. To put it plainly, Forex traders use leverage as a means of placing a high value trade whilst only risking a fraction of it. It is commonplace to find brokers advertising leverage of 100:1. Simply put, this means that for every dollar you deposit you can trade $100.

In this example, the broker has agreed to let you place trades with only 1% of their value put up as security by you. That 1% is called a margin: the percentage of the total trade required as collateral. This 1%, when expressed as leverage becomes 100:1 (a security of 1 is required for every 100 traded). Some brokers offer even greater leverage, such as 200:1 and 400:1 (which expressed as margins are 0.5% and 0.25% respectively).

So by using leverage as a forex trading strategy, you could control a trade worth $100,000 with only $1000 at risk when the quoted leverage is 100:1. This almost sounds too good to be true, especially for someone new to Forex who has a relatively small amount to begin trading with.

One key element that many brokers may neglect to mention, is that the leverage they quoted is actually the maximum available to you. You don’t actually have to use all of it. In fact, it is best to use as little as you can, because the more leverage you use, the more you are at risk from fluctuations in your trade value.

Using the previous example of buying a lots of $100,000 with a 1% margin (leveraging your $1000 by 100%). You now have open trades worth $100,000, but only a breathing space of $1000. If your lots fell in value by a mere 1%, your $1000 would be wiped out and your broker would make a ‘margin call’ (this means some or all of your trades would be closed automatically).

You may want to put in place a stop loss to prevent this happening, further narrowing your breathing space somewhat. So far we haven‘t even mentioned your brokers‘ spread, which would more or less leave you unable to suffer the smallest move against you. Yes I am being negative, and it is possible your trade will turn a profit. The problem is that due to the volatility present in the market, it is not unusual for a trade to move a little against you before turning profitable. Because you were too heavily leveraged, your trade closed at a loss because you had no room to breathe.

Sensible traders will not leverage their accounts too heavily. Instead of taking the maximum 100:1 on offer, a much more level-headed option would be to take say 20:1 (which would be a 5% margin).

In this trade you would be controlling lots valued at $20,000, but you now have a breathing space of 5%. Placing a stop loss that protects your investment but gives the trade room for a dip is now possible, and profiting from this trade is more likely.

Forex trading leverage will always be a good way to let traders use the market to their advantage with minimal risk, but when used recklessly then a slight move against you could see your trading balance wiped out very quickly. When used correctly, a leveraged account gives the average man in the street the opportunity to trade in lots that would have otherwise been out of his reach. When using leverage in your trading it is vital that you do not leverage your account too heavily and that it should be used as a tool to give you an advantage in the market, not your broker.

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