Most brokers these days advertise leverage as one of the selling points of opening an account with them. To put it plainly, Forex traders use leverage as a means of placing a high value trade whilst only risking a fraction of it. It is commonplace to find brokers advertising leverage of 100:1. Simply put, your broker will allow you to trade 100 times what you actually deposit.

In this example, the broker has agreed to let you place trades with only 1% of their value put up as security by you. That 1% is called a margin: the percentage of the total trade required as collateral. This 1%, when expressed as leverage becomes 100:1 (a security of 1 is required for every 100 traded). You will even find brokers who are willing to give you a higher leverage, even up to 400:1 (meaning they require only 0.25% security).

So by using leverage as a forex trading strategy, you could control a trade worth $100,000 with only $1000 at risk when the quoted leverage is 100:1. For someone looking to start a career in Forex trading, but has limited funds to begin with, this would seem like a gift from heaven.

One key element that many brokers may neglect to mention, is that the leverage they quoted is actually the maximum available to you. You don’t actually have to use all of it. In fact, it is best to use as little as you can, because the more leverage you use, the more you are at risk from fluctuations in your trade value.

Using the previous example of buying a lots of $100,000 with a 1% margin (leveraging your $1000 by 100%). You now have open trades worth $100,000, but only a breathing space of $1000. A fall in value of your lots by just 1% means your £1000 would be lost and your broker would make a ‘margin call’ (this means some or all of your trades would be closed automatically).

Putting in place a stop loss is a common tactic used here, but with this much leverage you will only give yourself even less room to breath. Then we have the spread put in place by your broker, now you find yourself with very little room to manouvre. Yes I am being negative, and it is possible your trade will turn a profit. However, Forex markets can be volatile and your lots could easily dip below your stop loss before turning around and becoming profitable. Because you were too heavily leveraged, your trade closed at a loss because you had no room to breathe.

Sensible traders will not leverage their accounts too heavily. Instead of taking the maximum 100:1 on offer, it would be far more prudent to take say 20:1 (which would be a 5% margin).

In this trade you would be controlling lots valued at $20,000, but you now have a breathing space of 5%. Placing a stop loss that protects your investment but gives the trade room for a dip is now possible, and profiting from this trade is more likely.

Forex trading leverage will always be a useful tool to allow traders to increase their capacity to trade, but for the inexperienced trader it can be a hard lesson in how a small movement in the market against you could be disastrous. With the right approach to using leverage, it is a method that allows an ‘average joe’ to trade in volumes they would otherwise not be able to afford. The important things to remember when using leverage is that you should not allow your account to become too heavily leveraged and that it should be used as a tool to give you an advantage in the market, not your broker.

Author Bio: Learn more about forex trading strategies and how to use forex trading leverage to your advantage. Automate your trading, with the MegaDroid Forex Robot.

Category: Finances
Keywords: forex trading strategies, forex trading leverage , forex margins