How to Manage Leverage
All types of trader’s issues inherent in the forex market can significantly increase trading risks. The vital amount of financial leverage afforded forex traders presents an additional risk that must be managed.
Leverage provides traders with an opportunity to enhance the returns. But leverage and the commensurate financial risk is a double-edged sword that amplifies the downside as much as it adds potential gains. The forex market allows traders to leverage their accounts as much as 400:1, which can lead to massive trading gains in some cases and account for crippling losses in others. The market allows traders to use vast amounts of financial risk, but in many cases, it is in a trader’s the best interest to limit the amount of leverage used.
Most professional traders use 2:1 leverage by trading one standard lot for every $50,000 in their trading accounts. That coincides with one mini lot for every $5,000 and one micro lot for every $500 of account value. The amount of leverage available appears from the amount of margin that brokers require for every trade. The margin is simply a good faith deposit that you make to insulate the broker from potential losses on a trade. The bank pools the margin deposits into one very large margin deposit that it uses to make trades with the interbank market. Anyone that ever had a trade goes wrong knows about the dreadful margin call, where brokers demand additional cash deposits, if they don’t get them, they will sell the position at a loss to mitigate further loss or recoup the capital.
Click on Below Link: How Professional Traders Use Leverage
Many forex brokers require various amounts of margin, which translates into the following popular leverage ratios:
The reason for many forex traders fail is that they are undercapitalized about the size of the trades they make. It is either greed or the prospect of controlling vast amounts of money with simply a small amount of capital that coerces forex traders to take on such huge and fragile financial risk.
Example: At a 100:1 leverage, it only takes a -1% change in price to result in a 100% loss. And every loss, even the small ones taken by being stopped out of a trade early, only the exacerbates the problem by reducing the overall account balance and further increasing the leverage ratio.
Not just the leverage magnifies losses but also increase the transaction costs as the percent of account value.
Example: If traders with a mini account $500 uses 100:1 leverage by buying 5 mini lots of a currency pair with a five pip spread, the trader with lots of a currency pair with a five pip spread, the trader also incurs $25 in transaction costs. Before the trade even begins, he or she has to catch up, since the $25 in transaction costs represents 5 % of account value. The higher leverage and higher transaction costs as a percentage of account value and these costs increase as the account value drops.
Click on Below Link: 3 Steps to Choosing Best Currency Pairs to Trade in Forex
The forex market s expected to be less volatile in the long term than the equity market, and it is obvious that the inability to withstand periodic losses and the negative effect of periodic losses through the high leverage levels are a disaster waiting to happen. The fact of forex market compounds these issues contains a significant level of macroeconomic and political risks can create short term pricing inefficiencies and play havoc with the value of certain currency pairs.