When you embrace the world of Forex trading as a beginner, there is an information overload that charges towards you. Whether it’s learning about geopolitical decisions and their effect on currencies, or basic market dynamics, the initial exposure to technical terms makes Forex trading appear like an ordeal.
But behind the confusion of buzzwords and technical jargon, all concepts of Forex trading can be dissected down to the foundation. Like all other complex terms from the realm of Forex, leverage is a particular entity that tops the chart of the most understood concepts. Here, we will explain what leverage means, and how traders can harness its potential to their advantage.
The General Concept Of Leverage
In a nutshell, leverage allows you to set up the trading environment in such a way that your returns can be maximized without having to increase the resources. If this concept is applied to the realm of trading, it means that you can access a greater portion of the trading market, without having to increase the number of deposits.
The advantage of using leverage while trading is of getting greater returns with a smaller up-front investment. However, it is important to note that while leverage increases your returns, it also exposes you to a more profound risk. In the world of finance, when you work with credit- that is borrowed money- and make money out of it, you still get to keep a percentage of the amount earned. Therefore trading with high leverage brokers is risky but rewarding.
Financial Leverage in FX Trading
Leverage in financial terms, specifically in the context of FX trading uses debt to buy assets. When traders use debts to buy assets, they do not have to commit too much equity. When assessing the financial leverage of a company, it is done by calculating the ratio between debt and equity. The higher the debt is, the greater the leverage will be.
When the debt utilized generates a return which is greater than the amount of interest, the trader is stated to be in a favorable position. However, it is crucial to acknowledge that an excessive amount of margin can be extremely risky because there is always a possibility to fail to repay.
Should You Use Financial Leverage?
Using leverage during trading is extremely lucrative, and many traders across the world use it to their advantage for the following reasons.
First and foremost, margin trading is utilized to expand a firm’s or individual’s asset portfolio and generate returns on risk capital. This can lead to an increase in the return on investment and earnings per share. Secondly, traders also use leverage to increase the potential of earnings. Another advantage of this type of trading is the favorable tax treatment. In many countries, the interest expense is deductible tax, which means that the total cost to the borrower is reduced.
Conclusion
Leverage in FX trading is basically an investment boost for traders. With the help of this margin, traders can open orders that are numerically mightier than their own investment. They can also gain access to much larger volumes than they would initially be able to trade with.
Frequently Asked Questions
What is the best leverage to use in forex?
It is generally agreed that a 1:100 to 1:200 is the best forex leverage ratio
Read this guide explaining the concept of leverage in forex trading
Can you trade forex without leverage?
The downside is that you will only make between 0.3 to 0.5 % monthly
Why is leverage in forex dangerous?
It can magnify your potential profit or loss of a trade.
What is a 1:000 leverage?
It means that you get $1000 for every $1 in your account.
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