What is leverage in forex and how to use it effectively
In order to explain what is leverage in forex, we must first consider its relationship with margin.
Leverage and margin
In order to open and activate an account with a forex broker, you need to make a deposit. The minimum deposit requirement varies depending on the forex broker and trading account type. With CM Trading, you can register for a bronze trading account with just $250.
However, when opening a position in a trading instrument such as a currency pair, you only need to fulfill the margin requirement. This is only a fraction of the total cost of your position and this amount of funds will be held from your account as collateral until your position is closed.
At CM Trading, you can open a standard lot in a currency pair, which is equal to $100.000 with just 0.50%. In simple words, you can control a position with a total value of $100.000 with just $500 and enjoy much greater profit potential.
This is the power of leverage, which is expressed as a ratio and in this case, CM Trading provides a leverage ratio of 200:1. For each dollar in your account, CM Trading allows you to trade with $200 instead.
It’s important to note, however, that leveraged trades are exposed to higher degree of risk as you are trading with higher amounts of capital. Large positions are quite vulnerable during volatile markets as it makes them particularly sensitive to the slightest price movements.
Therefore, when trading with leverage, you need to make sure that your account is always sufficiently funded to withstand any sudden price movements that can result in rapid losses.
Since the forex market is quite volatile and during certain periods exchange rates can move quite violently, all trading accounts are automatically monitored in order to ensure that they always have enough funds available to cover any potential losses.
As the market moves against your position, your available balance will start dropping until you close it. However, when your balance drops below a certain percentage of the initial requirement, your broker will issue a warning in order to either close your position or make another deposit to cover the required margin. This is known as a margin call.
If the market doesn’t start moving in your favor soon, or you fail to make another deposit to meet your broker’s requirements, you will eventually be stopped out, resulting in all your positions being closed automatically and the loss of your investment.
Tips for using leverage
Leverage carries risk but remember that it also provides a unique opportunity for traders to magnify their potential returns. With strict risk management rules, modest position sizing and careful use of stop loss and profit targets, you can use leverage to your advantage and minimize your exposure to risk.
While at CM Trading the default leverage ratio for currency trading is set at 200:1 by default, you can always contact your personal trading specialist to request a lower ratio that aligns better with your risk profile and tolerance.
In general, you need to carefully consider your trading goals and manage your trades according to the potential risk and reward. The majority of traders calculate the potential risk of a trade beforehand in order to identify where they should place their profit target and stop loss parameters. These steps are vital in minimizing your losses and ensuring that you don’t exceed your margin requirements.
Also, if you are still unsure how leverage and margin apply to your trading strategy, you can always practice trading on a free demo account. This way you can try trading in a risk-free environment and test your limits. If you manage to achieve consistent profitability, you can eventually transition a live trading account using real money.
Trading forex on leverage allows you to enjoy greater profits by opening larger positions that your initial capital affords. If you have $1.000 in your trading account, CM Trading allows you to open positions of $200.000 in value since it provides 200:1 leverage for most currency pairs.
Large positions such magnify your investment and give you access to higher returns even with a small initial deposit, but you always need to remember that this can also increase the probabilities of getting a margin call, being stopped out, or losing your entire investment during periods of heightened market volatility.
If you need further information regarding leverage and margin requirements, you can always get in touch with your personal trading specialist for guidance and advice.
Open your CM Trading account now to discover how you can use leverage to improve your trading results today.