Leverage traps in Forex
High leverage and a lack of risk management discipline are the two main killers for rookie Forex traders. If effective risk management is not implemented, this might result in significant losses.
In Forex, leverage is comparable to margins, but not identical. The number of times you can leverage your entire quantity of capital is referred to as leverage. The maximum trading leverage will then be determined by the margin requirement.
Almost every new trader will fall for the leverage trap when they enter the Forex market. They see a 1:500 account with a minimum £50 deposit and think they can use their account repeatedly because that’s what the data on their compound Excel spreadsheet indicates.
If you don’t have much experience in the Forex market, even starting with a few thousand dollars can be a bad choice. If you are a novice trader, we recommend that you begin with a demo account to gain a better understanding of how the market operates before plunging in with both feet.
Don’t be fooled by manipulated scenarios
It’s common knowledge that most brokers will manipulate situations for a profit. With 90%+ of Forex traders losing, the broker can offer accounts that build upon their success and not the success of traders. They do this by controlling the spreads, leverage, and other factors that can be adjusted in trading scenarios.
Set trading guidelines for yourself before deciding which trading account to open, and stick to them with a low-risk strategy that focuses on long-term growth. You may be thrilled about increasing your competence and winning over a wide sample of trades without having any short-term emotion linked, but you must set realistic expectations for yourself and choose a reasonable leverage option.
Leverage and margin
If you are unfamiliar with margin in trading, check out our recent blog covering the basics. Leverage is essentially managing or trading a large amount of capital using a much smaller amount. The remainder is then borrowed to control more capital.
If you have £1,000 in a trading account with 1:100 leverage, then you will control £100,000 with £1,000. If the leverage was 1:1, you would control £1,000. Now it may seem like you should apply as much leverage to your account as possible, but placing a large position on a £1,000 with 1:100 is almost certain to end in a loss or blown account.
We have seen authorities step in over the years to bring down the maximum in certain regions and situations. We have also seen brokers offering 1:2000 leverage with a £10 deposit. While leverage is beneficial, too much of it, especially combined with poor risk management, may be disastrous.
How to use it?
As a beginning trader, using lower leverage is a terrific approach to get your feet wet and increase your account. As previously stated, there are numerous drawbacks to trading with high leverage. It will eventually enable you to increase the size of both your successful and lost transactions. But keeping a controlled 1:5 to 1:30 leverage is ideal for growing any amount of capital over a long and sustained period.
As mentioned in previous blog posts, we need to stay away from margin calls. We do this by making sure our risk management is perfected and we allow ourselves to survive any losing streaks to hopefully come out on top.
Consider the correct amount of leverage
When opening a Forex account, you should decide on the appropriate level of leverage after considering the associated fees. When you utilize large quantities of money, transaction fees can rise, but you also want to leave room for rewards.
The higher the leverage, the higher the commissions and swaps on your trades. It is possible that transaction costs can hinder your success if your leverage is too high, not to mention destroying your ability to trade much large lot sizes.
Survival with a decent trading plan
With a sound trading plan and a modest leverage account, you can survive, but as you get more charting experience and a better understanding of the markets, it’s a good idea to gradually increase the leverage while still adhering to good risk-management principles.
All these factors depend on the trader’s style and situation. For example, if a trader places mostly swing positions with a high pip stop loss, then an increase is not necessary. But for day traders who operate with 15-50 pip stop losses, leverage will be used more naturally. So many factors are used to determine the correct amount of leverage.
The moral of the story is that leverage should never be underestimated. Make use of it to increase your capital and your success. It’s a powerful instrument that can either help or hurt traders. Never trade with a short-term attitude and always strive to improve your skill set. With low leverage, you can trade safely and protect your capital. Be honest with yourself about your goals and treat the market with respect.