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Yael Warman, Content Manager at Leverate, takes an interesting look at the use (and dangers) of leverage in forex trading.
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A new Asian all-you-can-eat restaurant opened a few weeks ago around the corner from my brother’s house and we made plans to go this past weekend. I’m usually wary of all-you-can-eat places, but this one had been raved about by our friends, so I pushed aside my predispositions and decided to enjoy the night out.
We ate to our heart’s content.
There was sushi, tepanyaki, all kinds of noodles and rice, chicken in various sauces… As I finished eating and sat there with the first button of my jeans unbuttoned, I questioned the need for these types of establishments. Do we really need to be eating all we can eat? Are we bears going into hibernation?
The fact that we can eat all we can eat certainly doesn’t mean we should.
Most newbie traders are dazzled by the insane levels of leverage available in Forex.
Anything from 50:1 to 200:1 is a go in Forex trading and entry level barriers are extremely low, causing a wannabe investor with a couple hundred bucks burning a hole in his pocket to jump in with both feet at the get-rich-quick mirage appearing right before his eyes.
Just because a broker will allow you to open up an account with $25 and leverage the heck out of it, doesn’t mean you should.
Leverage does have a potential to exponentially enlarge your profits, but it can do the same to your losses. The higher your leverage, the higher your risk and as much as a highly leveraged trade can make you a profit of 100%, it can also deplete your trading account in a matter of seconds.
Although I may be cautioning you against leveraging high levels here, I must say leverage is a beautiful thing. Leverage can prove to be a great part of your trading strategy if you learn how to use it in your favor, rather than letting it get the best of you. Just because a broker offers you great levels of leverage, doesn’t mean you need to accept a one-size-fits-all deal. Leverage is flexible and it should be customizable to meet your needs.
How much should you leverage then?
If only it was that easy. You need to analyze several factors in order to determine how much leverage is right for you. For example, how much are you paying your broker in transaction costs? The higher your leverage level, the higher your transaction cost relative to your trading capital is. Another factor is your available capital. Experts recommend that you have at least $1,000 when opening a micro account, $10,000 for a mini account and $100,000 for a standard account.
As brokers face increased competition, the offerings for low initial deposits and high leveraged accounts are soaring, but as a trader, you should know that with great leverage comes great responsibility (Spider-man may not have said it quite like that, but you know what I mean). Understand leverage so you can determine when you should use it and when you shouldn’t. This is the key to your trading success.