Forex Leverage Facts For Professional Traders

What Is Leverage?

Investopedia defines leverage as, “the use of borrowed capital, such as margin, to increase the potential return of an investment.” Let’s break down a real-life example. Bob is a working professional with a few extra bucks to invest. Bob decides he wants to trade currencies in the foreign-exchange market. Bob has no formal financial background. He is actually an engineer by trade, but likes the possibility of earning money trading currencies online. After a little internet research, Bob decides to open a forex account with Broker ABC.

Broker ABC offers Bob 100:1 leverage. This means that Bob can control $100 in the market for every $1 he has on deposit at Broker ABC. Therefore, since Bob has funded an account with $1,000, he can trade positions of $100,000. Broker ABC only requires Bob to have that $1,000 as margin against his trading position.

Now, leverage is extremely attractive to many new traders because it offers the potential of quick riches. Unfortunately, most new traders do not realize that leverage is extremely dangerous and the cause of many traders losing all of their money.

How do traders make and lose money with leverage?

If Bob uses this 100:1 leverage from Broker ABC, then Bob will be able to open a position of $100,000, which means that each 1 pip movement will be worth $10 for Bob. Therefore, if Bob buys EUR/USD at 1.3000 and closes it out at 1.3100, Bob will have earned $1,000, or 100% of his account equity. To be clear, the fx market can move 100 pips in a matter of 30 minutes or less during a very volatile market.

The reality is that traders will generally never turn a small trading stake into a large one by using excessive leverage. Most often, a trader will open a trade like USD JPY with a $100,000 position with a $1,000 account, and within a few hours, the entire account will be wiped out due to a 100 pip move against the trader. The industry statistic is that 95% of online forex traders lose money and quit trading, and one of the leading causes of trader fatality is the use of high leverage.

How Much Leverage Does A Professional Trader Use?

The answer to this question can be quite enlightening for new traders. Many professional traders do not use leverage at all. Or if they are leveraged, it is very low, such as 2:1 or 3:1. Nearly all professional traders who are managing millions of dollars are never leveraged 100:1!! If professional traders do not use extremely high leverage, why is that new traders believe they can use something so powerful and dangerous and do well with it?

Recently, the National Futures Association passed new regulation that has capped leverage in the United States to 50:1. Although 50:1 leverage is still available at most retail fx brokers in the United States, a trader should always understand that leveraged trading involves a substantial risk of the loss of all funds
 

 

 

 

 

 

 

 

 

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Forex Leverage Facts For Professional Traders