Understanding the pros and cons of Forex leverage is one of the fundamental concepts in risk management. This is the first step towards being profitable in trading. The leverage available for Forex trading starts from 20:1 and goes up to over 500:1 depending on the broker, regulation and the trading instrument.
Higher leverage means you can trade with larger lot sizes for same amount of capital.
The margin required for trading EURUSD is given below for different leverages:
It is easy to see that with higher leverage traders can make higher gains for the same price movement.
Most new traders get carried away by the gains offered by higher leverage. Many traders have fallen prey to this hidden risk – mostly because they have not considered the downside risk.
The following table puts things in right perspective when the loss seen for same price movement is considered.
Trader “D” will have a margin call and lose most of his account. While trader “C” would have lost almost half of his account and will need to gain 200 pips to just get back the amount lost.
When used wisely, Leverage is a friend. No trade is guaranteed to win. Never attempt to over-leverage. Always consider the downside risk and set risk accordingly. And, never risk more than 5% on any trade.