UNDERSTANDING LEVERAGE TRADING IN 2022: THE PROS AND CONS

Think of leverage as a tool.

A tool that can give you the power to trade more with less.

While I’m not taking you to the mystical world, this is what it is all about.

You get borrowed capital when you open an account with the broker.

Source: Yahoo Finance

Each broker has different leverage ratios.

I’ll get to that in a minute.

Through ratios, you can open a trading position.

Leverage in forex trading

Let’s give you an example.

Say you want to buy 3000 units of EUR/USD.

To buy 3000 units without leverage requires $3000.

However, with leverage of 1:100, you only need $30.

See, this is the magical world of leverage.

It allows you to open much larger positions.

What are Leverage ratios?

Let’s tell you more about leverage ratios.

Every forex broker gives you an option of leverage.

You can see a separate section on leverage on brokers’ websites.

The leverage you get from brokers depends on the regulations.

For instance, the UK’s FCA doesn’t allow a leverage ratio over 1:30.

Some brokers do offer astronomical ratios like 1:2000 and 1:3000.

With 1:3000 leverage, if you have $5, you can set a position of $15000 value.

That’s the lure!

It sort of draws you towards it to trade with less capital.

Source: Commodity Futures Trading Commission

But you should know that it is a word having two edges.

With leverage, you have both sides of the coin.

What it means is it can make or break your trading.

If it gives you the chance to gain, it can also prove risky.

You should understand that the greater the leverage, the more you are at risk.

Let’s prove this point with a case of EUR/USD.

Suppose you want to go long EUR/USD with 1:100 at 1.3700.

You have placed a stop-loss at 1.3650.

Your balance is $1000.

You have picked a mini lot as a lot size.

A Mini lot equals 10,000 units or 1 in dollar value.

You need a $137 margin.

You don’t need to calculate margin, as many brokers have a calculator for this.

I’ll explain the margin in a moment.

If the price moves in your favor by 100 pips, you make 1 x 100 = $100.

Let’s say the opposite happens; then you lose $100.

So, you see how leverage acts.

The greater your capital, the greater your risk.

Risks of forex leverage

I don’t like to use too much leverage.

I normally use the leverage of 1:20 or 1:30.

With these ratios, I can trade without risking too much.

Leveraged trading is about the funds you borrow from your broker.

Your broker provides you with funds, and you do trading.

It sort of magnifies your buying power.

What you can trade with leverage isn’t possible without it.

Will leverage trading bank me a cool $100 a day?

Well, let’s not get our hopes high.

Leverage trading is not gambling.

You have to apply risk-management strategies with it as well.

For instance, I never trade with more than 1 or 2% of my trading balance.

As I explained above, leverage swings both ways.

So, you have to take it easy.

Day trading involves taking multiple or a single position in one day.

When you use leverage, you sort of magnify your gains and losses.

But here’s the deal: use a lower leverage ratio in day trading.

Why?

Because in day trading, you never know what’s going to happen.

You see a trend going in your direction, and suddenly, it goes the other way.

You have to be smart about this.

When day trading, use minimum leverage like 1:30 or 50.

Along with this, you should keep your risk per trade 1% or 2%.

In this way, even you lose your day trade/trades; you are not gonna lose big.

Brokers don’t give you leverage from the goodness of their hearts.

They need some insurance or security.

To control a $5000 or 10,000 position, your broker will set aside specific funds.

If you have 1:100, you have a $1000 buying power with $10.

The $10 amount you must have in balance acts as a margin.

It’s sort of a good faith deposit that your broker requires.

Forex margin

You must have some margin in your account if you want to leverage.

Brokers with high leverage, such as 1:1000, have lower specs.

For instance, in our previous example of 1:100, the margin was 1%.

It means your account balance’s 1%.

For instance, if you have a $5000 account, the margin is $50.

You only need a small amount

With leverage, you have more trading power.

You only need to invest a fraction of equity with leverage trading.

With more, you require less account equity.

Tool against low market moves

Market volatility is super significant!

Sometimes the market can go crazy, but other times it lays low.

So, in a situation where it lays low, you need leverage for profits.

When there is low volatility, it multiples your profits.

Leverage brings more

You know the forex market spins around 24/7.

It’s an owl that never takes a breather.

It runs from Monday to Friday, 24/5.

Using any leverage, you can take advantage of it.

You can open positions multiple times during the week.

By doing this, you can gain more.

Short and long

For forex, you can buy or sell a pair.

You just have to know the trend’s direction and enter a position.

Leverage plays a part in either scenario.

You go long or short; you can gain either way.

Quick returns in a short period

It gives the option of making quick bucks in a short period.

By using higher ratios like 1:1000 or above, you can take advantage of the market moves.

Plus, if you apply risk management with high leverage, it’s cherry on the top.

 Multiplies losses during high volatility

When there’s a high market move, using high leverage can backfire.

During high volatility, forex pairs can make wild movements.

You don’t know where the trend is heading.

A high figure like 1:2000 can eat up all your accounts in this scenario.

The danger of a margin calls

You need some balance in your account for trading.

That’s how your broker offers you leverage.

When your balance goes low, your broker needs more margin.

So, that you can keep your positions open.

If you don’t deposit more, you can get a margin call.

A signal of a margin call suggests your balance is zero.

That’s why using low leverage avoids calls.

A large ratio doesn’t mean you have to use it.

Although it gives you more buying power, remember it works both ways.

You have to use leverage according to your trading plan. 

There’s a reason 43% of retail investors are trading with leverage.

If you want consistency, you have to keep the leverage ratio low.

You have to use it in a way that can keep your run consistently.

Don’t go for scalping or intra-day trading when it comes to leverage.

It’s tempting to apply a high ratio for scalping for quick bucks.

However, the risks are not worth it.

You can end up blowing your account.

There is no perfect leverage ratio.

I would suggest not using more considerable leverage.

Try using more immense leverage on a small trading account if you want to try it.

So, even if you blow your account, you don’t lose too much.

A leveraged ETF allows you to hold assets like forex pairs.

When they go up, your leveraged ETFs go up.

ETFs are like a basket of assets.

You buy them like a forex pair.

ETFs contain these assets from the index like the good ol’ S&P500.

When the sector goes up, you’ll profit from it.

Leveraged ETF chart

Using leverage with ETFs is like any other asset.

You select your leverage ratio, and voila!

So stats suggest $7.74 trillion worth of ETFs managed globally.

Can you take a piece of the pie?

Of course, you can!

You just have to apply risk management, and you are good to go.

Like your usual long-term investments, ETFs can bag you big bucks.

If only you follow the basic trading plan and apply risk-management with it.

See, leveraged ETFs are a bit puzzling, so you have to make sure you use the right leverage.

Chart showing holding of leveraged ETFs for long term

Should I use higher leverage like 1:100, so I can bag some cool bucks?

If you use a hefty leverage ratio like 1:1000, then it’s super risky.

And you won’t hold it for the long term.

Plus, a gentle reminder that leveraged ETFs cost you more than non-leverage ones.

So, if you are going for long-term investments, consider this point.

Is leverage a loan?

Yes, leverage is a tool that gives you more buying power. So, you can trade more with fewer funds. The broker provides various leverage options, depending on the broker’s regulations.

Can you make money in forex without leverage?

You can make money in forex without leverage, but it is a snail process. Leverage magnifies your profits. It gives you more buying power, so you can open larger trades with small funds.

How to choose leverage ratio?

There isn’t a single answer for choosing forex leverage. Instead, you should select leverage according to your trading plan. However, more enormous leverage brings larger risks.

Why is leverage necessary?

It gives you the option to trade more with less capital. Almost every broker provides it. You need leverage when there’s downward market movement, so you can gain from any market fluctuations.

Is leverage safe?

Forex leverage is safe as long as you apply risk-management strategies with it. Using proper risk management and going according to your trading plan won’t affect you.

FINAL THOUGHTS

So, that brings us to a close.

You don’t have to shy away from leverage, promising to not use it.

The downside is it can deficit your account.

However, it won’t break your sweat if you follow risk management.

So, the next time you search “how does leverage trading work,” go through the article again.