How to choose the right leverage

17-11-2020

Leverage is a financial strategy where a trader actually uses more capital than he/she owns. By offering leverage, a brokerage company provides funds to open deals in proportion to a deposit on a trader’s account.

It’s considered that 1:100 is the best forex leverage ratio, although brokerage companies now allow choosing leverage that’s a perfect fit for you. For example, Gerchik & Co enables you to choose leverage from 1:5 to 1:100, while other companies allow you to increase it up to 1:200, 1:500, and even 1:1000.

Contents:

1. What Is Forex Leverage
2. Stock Market Leverage
3. Leverage: Benefits and Risks
4. Leverage: Trader’s Benefits
5. Leverage Risks
6. Which Leverage Is Better to Choose
7. Is There Any Way You Can Change Leverage When Trading

What Is Forex Leverage

A standard lot is the equivalent of 100,000 or 150,000 units of the base currency in the forex market, depending on the pair. This means that you need to spend USD 118,050 to open a deal with one lot in the EUR/USD pair at a price of 1.1805. However, not all traders can operate with such amounts.

Using 1:100 leverage, you need to spend 100 times less to trade with the whole lot. Nevertheless, we should keep in mind that a broker takes USD 1180 as collateral when providing a loan. Let’s use a new angle in this case. If your trading account is, for example, USD 10,000, you can trade 100 times more— USD 1,000,000—when using 1:100 leverage.

Stock Market Leverage

In addition, market players use leverage to trade stocks, but it’s less than in the forex market in most cases and represents a ratio of trader’s personal funds to a lot being traded. You can measure leverage by the amount of margin funds that may be different for different SPOT instruments or the derivatives market. For example, with a 20% margin call, leverage will be 1:5, i.e., your broker takes ⅕ of asset value as collateral when concluding a deal.

It should be noted that you can take securities from a broker—it’s possible to open sale deals thanks to that—when trading stocks “on credit” in the stock market.

Leverage and here’s what you should know about it

Leverage: Benefits and Risks

We now know what leverage is. It seems that its benefits are obvious, but let’s keep in mind that you risk in proportion to the opportunity to amplify your returns. Below we delve into the benefits of leveraged trading and the circumstances to take into account when you embark on margin trading.

Leverage: Trader’s Benefits

1. Start trading with small amounts in the forex market

As we know, it’s extremely expensive to trade with the whole lot in the foreign exchange market, so not every trader can afford it. In the case of margin trading, novice traders can reduce the required capital amount. Let’s say, if you have an initial deposit of USD 1000, you can actually conclude deals for up to USD 100,000 when using 1:100 leverage, and these are great opportunities.

2. Proportionally increased profits Leverage allows you to increase your trading lot

For example, if your account is enough to open a deal with 0.01 of a lot without using the margin conditions, then you can open a position of 1 lot with 1:100 leverage. This means that your profit in that deal will be 100 times higher. All in all, leveraged trading is perfect for boosting small deposits.

3. Access to diversification

The more you have on your trading account, the more deals you can open. Consequently, you can diversify your trading portfolio and increase the likelihood of profitable deals.

4. Favorable credit terms

By using leverage, you actually take a loan from a broker. In this case, you pay a spread, i.e., a broker’s commission for using money. In addition, you pay a swap fee to keep a position open overnight. If you took the same amount from a bank, it would be much more expensive. Plus, all borrowed funds would have to be paid off with interest even if you didn’t use them.

Leverage Risks

Margin trading also has a downside—risks—along with its benefits.

1. Higher profits equal higher risks

Leverage increases your lot, profit, and loss proportionally if you get it. In this case, your money is used, not the broker’s resources.

2. It’s easy to lose but hard to recover Increasing your risk is a way to blow your trading account quickly

And with each unprofitable deal, you decrease your own funds that can be used to open trades. This means that it becomes more and more difficult to restore your account to its original level. If you lose half of your trading account in one or two leverage trades, you are faced with the task to make 100% to the remaining deposit in order to break even.

3. Set lower stop-loss orders

By observing your money management rules, you can use leverage safely. In this case, you should calculate your lot, taking into account the risks. The less you put your deposit at risk in percentage terms, the lower a stop-loss order you can set in pips This immediately reduces the number of potential entry points.

4. Fatal errors in money management

When trading without leverage, you can seamlessly increase your stop-loss orders and lot. However, even a small mistake in risk management threatens with losses that will grow in proportion to your leverage. Risk and money management are the key pillars of profitable trading. You can learn more by completing training with a mentor bot.


Which Leverage Is Better to Choose

You now know the benefits and risks of leverage, and after considering all the pros and pros, you can choose the one that suits your goals and deposit best.

If you have a small account and wish to increase it, it’s better to take higher leverage. However, if you are a beginner and are yet to have a trading strategy that gives 75% of profitable deals, then it’s better to take as little leverage as possible.

Thus, the traders need to reconcile their financial capabilities (account size) with profit goals and willingness to take risks. In this case, it’s better to strike a balance and keep in mind that the choice of leverage is only one of the components in any successful trading. Therefore, you should approach the task in a comprehensive manner.

Inexperienced traders are better off choosing any minimum leverage, e.g., 1:10. At the same time, it’s better to start trading with USD 10,000 in the financial markets. But what to do if you have a small amount to start with and 1:10 leverage isn’t enough for you?

1. Don’t borrow money in order to increase your deposit. If you choose between increasing leverage and trading with borrowed funds, the first option is safer.

2. Decide which is preferable for you: high-profit potential or minimal risk. In view of this, make a decision about what your leverage will be. Remember that the higher it is, the more serious risks you take, but the potential profit is higher.

3. Trade with a pre-tested strategy offering a positive mathematical expectation.

4. Follow your money management rules carefully. When calculating what you are going to spend on a deal, consider the risk in the deposit currency and take into account your leverage.

If you are an experienced trader and your trading strategy produces a large percentage of profitable deals, you may well increase leverage in order to improve your profits in the deposit currency.

Is There Any Way You Can Change Leverage When Trading

Forex brokers, in particular Gerchik & Co, allow you to change leverage on your account. You can do so in your Personal Account by yourself. If there are no placed orders and open deals on the account, leverage can be either decreased or increased. If there are open positions, your leverage can be changed only upwards.

When should you change your leverage? If the account has already experienced losses, it’s better to stem the risks by reducing leverage. This will enable you to recover your losses carefully.

Leverage is a great opportunity to make more money with less startup capital. However, any trader should use it wisely in order to achieve the goals.

Next time we’ll walk you through how to analyze unprofitable deals correctly.


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