Forex leverage represents credit facility enabling a trader penetration in the trading contracts that require huge investment while having a nominal amount of real cash available in his trading account.
Forex Leverage is the amount of money obtained through credit commonly provided by the brokers. Leverage ratio established on the agreed amount of marginal account deposit that is mutually agreed between the investor and broker at the time of opening a forex trading account. Leverage ratio depends on the margin ratio. 100:1 leverage means that for every $1 a trader can put a trade worth $100.
For example, for putting the trade amounting to $100,000 a trader needs to have $1000 in his account by using the 100:1 leverage.
Leverage has the ability to make bigger profits but it also has the capacity to enlarge the losses by the same proportion. High leverage represents higher exposure to risk. So it should be used very carefully and wisely.
A trader should devise the strategy for utilizing the leverage facility wisely. Leverage facility permits the traders to acquire access larger amount of capital but it’s not reasonable to intact the whole facility with the single transaction. That means carefully applying the diversification strategy by using the small trading lot sizes.
A trader has $5000 capital in his account. On the basis of 100:1 leverage the trader can open a trade worth of $500,000. Let’s suppose;
On the other hand, if the trader uses the leverage wisely and uses the base capital by investing in small trading lots in different pairs, the result would be less harm. One major benefit of the diversified portfolio is that if one investment makes a loss, the profit from other investments will set-off this loss and the end position of the trader is quite stable. The lesson of the diversification is that do not put all the eggs in one basket.
Stop loss order is another very effective technique used to minimize the exposure to risk. The technique is used to limit the trading loss and its limit is determined by the trader. For example, the EUR/USD opening trading position is $1.1245 a trader can limit the loss on this particular trade by setting the stop loss order at $1.1238. The trade was automatically close when the pair price touches that amount i.e. $1.1238.
In the case of favorable position in an ongoing open trading i.e. when a trader making a progressive profit in the present forex trading and he believes that this situation continues to some extent of time. The use of leverage at this moment enlarges the profit of the trader.