Forex traders use different leverage levels based on their trading strategies and their ability to anticipate market movements. Usually, short-term traders like scalpers and day traders tend to trade with high leverage since they usually look for price changes within a short period. By contrast, long-term traders typically use low levels of leverage.
Regardless of how attractive leverage may seem, you should always keep in mind that excessive leverage can wipe out your entire starting capital in a matter of seconds. Leverage is directly related to the equity of your forex trading account.
Let’s assume you are trading a currency pair with $100 and you are not using leverage. You can achieve the following results:
- With an increase of $10, you get a profit of $10.
- If the trade falls by $10, you will suffer a loss of $10.
When you apply 1:100 leverage, you get different results:
- With an increase of $10, you get a profit of $100.
- If the trade falls by $10, you will suffer a loss of $100.
The greater your leverage, the more volatile your account equity will be. Likewise, lesser leverage means less volatile your account equity will be.
Example using High Leverage:
Let’s say that Trader A has a $10,000 cash account. He decides to use the leverage of 1:50, which means he can trade up to $500,000. In forex terms, that’s 5 standard lots.
In forex trading, there are three basic trade sizes: Standard lot (100,000 units of the quote currency), the Mini lot (10,000 units of the base currency), and Micro lot (1,000 units of quote currency). Price fluctuations are measured in pip movements, and the pip value depends on the lot size.
Assuming the trader purchased 5 standard lots in USD, a single pip movement would earn the trader $50. Likewise, if the trade fails, the trader loses 50 pips, i.e., 50 pips x $50 = $2,500. That’s 25% of the $10,000 account.
Example using Low Leverage:
Here’s what Trader B did. Instead of using the maximum leverage of 1:50, he used a conservative leverage ratio of 1:5. If Trader B has $10,000 in cash, they can trade $50,000 in currency. A mini-lot is equal to 10,000 units of currency, and each pip is worth $1. As Trader B has 5 mini lots, each pip movement could earn him $5.
In case the investment fell by the same amount, by 50 pips, then the trader would lose 50 pips x $5 = $250, which is just 2.5% of the total position.
Beginner traders should only select the level of leverage they feel most comfortable with. A lower level of leverage, such as 1:10 or 1:50, may be more appropriate if you are conservative and don’t like taking risks. Choosing the right forex leverage level allows you to earn more money from your trades and helps you achieve financial stability.
