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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