What is leverage in forex?
Leverage in forex has the meaning as a comparison between,
the amount of trader capital and the number of loan funds from the broker.
Let say, if you open an account with a leverage of 1: 200, it means that by providing capital of 1 dollar, you use a fund of 200 dollars, with 199 dollars from it as a “loan fund”.
Leverage is written in the ratio of comparison, for example, 1: 1, 1: 100, 1: 500, and so on.
That is if your funds are $ 100 and use 1: 100 leverage then the $ 100 has 100 times the equivalent of $ 10,000.
Because in forex trading the amount of the transaction is measured in units of Lot.
Where 1 lot is worth $ 100,000, then when you want to trade 1 lot, you don’t need to provide as much as $ 100,000, but only what percentage is in accordance with the leverage you use.
This is a broker with the regulation of the International Financial Services Commission (IFSC) of Belize, guaranteeing better security.
TenkoFX offers variations in leverage from 1: 1 to 1: 500 with the conditions of the type of account chosen.
The minimum deposit is only 10 $ for STP accounts and Crypto accounts, while ECN accounts require 100 $ minimum.
What is leverage and margin in forex?
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In a literal sense, leverage is a feature that allows investment strategies to use borrowed money.
The aim is to get greater profit potential. If you have heard the term companies with large leverage.
That means the company has more debt than its equity.
Then what is the relationship of leverage with forex trading?
As stated above, “trading using leverage” can be interpreted as we borrow money temporarily in a brokerage company in a certain nominal amount
By providing collateral in a smaller amount, but the amount is proportional to the loan obtained.
Well, this collateral is called “Margin”. The greater the leverage (or in other words, the smaller the forex margin), the more “collateral money” needed is even more efficient.
Example using leverage.
For example, your account uses 1: 100 leverage, so when you want to trade for $ 1000, you only need to provide 1%, which is $ 10 to be submitted to the broker and used as collateral.
By submitting the collateral you have the right to use brokerage money and make a transaction of $ 1000.
Another example: You have a capital of $ 500 and your broker has a leverage of 1: 100, so if you want to buy 1 mini lot ($ 10,000).
The capital in your account will be taken by the broker for $ 100 (1% x 10,000) and the remaining $ 400 on your account it is used to hold loss.
And if one day you have liquidated the buy position, the $ 100 margin will be returned to your account.
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Using leverage in forex trading makes you able to trade assets with a value that is far greater than the amount of capital you deposit.
For example, a leverage of 1: 100 allows traders to trade amounts that are 100 times larger.
So, you can trade $ 100,000 with a margin of only $ 1000.
If the leverage applied is 1: 200, you can trade 200 times more
big and so on.
To calculate the amount of leverage based on margin, that is by dividing the total value of the transaction by the margin requirement.
Margin Requirement (MR) is the minimum fund needed to be able to make transactions.
Also be interpreted, minimum collateral that traders must provide in order to be able to make transactions.
The higher you choose to leverage, the smaller the required margin requirements.
However, leverage has one hidden risk.
Because the function is to increase funds temporarily if you are not vigilant
You may be forced to bear bigger losses than expected.
The greater the leverage, the greater the possibility that this risk will be fatal for us. Just imagine, for example, we deposit 200 Dollars with 1: 1000 leverage, then experience a loss of 150,000 Dollars.
At first glance, the funds in the account still have 50,000 US dollars left, but in fact, the funds are only 50$ left.
Based on an understanding of this leverage, we can conclude the benefit of leverage
- Minimizes the minimum capital requirements that we have to deposit with the broker.
- Increases the purchasing power of the capital that we have deposited.
Leverage ratio in forex.
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In forex brokers, there are already a lot of leverage options for you.
If calculated mathematically, each of the forex leverage will also have different effects on the margin to be used. Try to see the table below:
The table above explains what percentage of forex margin is needed from your total transaction, according to the leverage you choose.
If you trade 2 lots on 100,000 base units, the total transaction becomes 200,000 USD. If you choose 1: 400 forex leverage, you only need to provide collateral of 0.25% of your total transactions.
Preferably, do not choose the type of leverage that is too low like 1: 1, because the capital needed, is definitely very large.
But too high leverage like 1: 1000 and 1: 3000 will also be very dangerous if not used properly.
Choosing high forex leverage carries greater risk than small leverage.
This is because the use of lots that exceed the ratio of normal capital strength has the potential to obscure objective considerations when making trading decisions.
Dangers of Forex Leverage.
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In the margin trading that we do in the forex market.
Forex leverage does not really affect the number of profits or losses obtained.
But there are still many traders that call leverage as a double-edged sword.
Leverage that is truly dangerous in the context of a double-edged sword if leverage forex that is used by traders who do not understand and understand the concept of good money management.
Take a look at the table below. For example, if you have 10,000 USD, by opening a position of 1 lot on the EUR / USD pair we will try to calculate how many maximum lots you can open with each forex leverage option.
The calculation above aims to show the strength of leverage, which can be leading the occurrence of over lot disease.
Only because forex margin resilience still shows thousands of percent.
So without careful calculation, a beginner trader will add his position casually.
And so on until the free margin is quickly eaten by losses.
What disadvantages of choosing high forex leverage?
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A 100% margin call will occur when the equity we have is equal to the margin to open a position.
For example, we choose 1: 3000 leverage as above and open 1 lot.
You will only be exposed to the Margin Call when your balance is only 33 USD.
Whereas if you choose forex leverage 1: 100, you have been hit by the Margin Call since your balance is 1,000 USD.
Among them, using 1: 100 leverage is certainly safer because you can have 1000 USD remaining, far more than 33 USD.
This is why leverage is often called a double-edged sword.
On the one hand, he is able to make you gain profits many times over, on the other hand
It is also able to erode your funds instantly.
If you already know and master the principle of good money management.
Then it should be no matter what forex leverage is used, it will not be a problem for you.
But if not, you should first learn how to choose good leverage.
Forex Leverage in the View of Professional Traders.
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If we speak in the context of professional traders, they usually choose maximum leverage of 1: 100.
Small isn’t it? As explained above, forex leverage can give us a large transaction advantage, but can also turn to attack us as traders.
This is what professional traders try to avoid.
However they are also humans, the place is wrong and greedy.
Professional traders can be tempted by the lure of getting a high return from only one position.
Therefore, besides limiting using good money management.
They will also limit their behavior by limiting the use of forex margin.
With low forex leverage, the margin needed to open a position will be of considerable value.
This will not provoke them to over lot, because the amount of available forex margin has been limited.
In general, as repeatedly explained above, actually, leverage has nothing to do with the amount of loss or the profit you get in one position.
But leverage can affect the number of lots and positions that you can open.
To choose this leverage you may have to pay attention to what type of trader you are.
- If you are a trader with a high-frequency level without limiting the number of positions, maybe high leverage is right for you.
- If you are a trader with a clear daily target or may have a maximum position limit every day, low leverage might be right for you.
Tips for Choosing Leverage.
Based on the understanding of the leverage function above, here are some tips for choosing leverage:
- Avoid too high leverage. As a rule, choose leverage only in the range of less than 1: 1000.
- Consider how much capital is ready to be deposited. If capital is below 10,000 Dollars, then you should choose three-digit leverage, for example, 1: 100, 1: 200, and so on. If capital is above 10,000 Dollars, you can choose double-digit leverage, such as 1:20, 1:50, and so on.
- Consider how often trading will be done. If you are going to trade every day, and once you can open more than 10 trading positions, you should choose three-digit leverage, for example, 1: 100, 1: 200, and so on. However, if only once you want to open 1-2 trading positions, you can choose double-digit leverage.
Leverage is a feature in forex that gives retail traders the opportunity to make transactions using small capital to boost profits.
But this can also make forex traders lose more quickly if he does not trade with the right money management because high leverage might encourage traders to open high lots.
So you should pay attention to the tips for choosing the leverage mentioned above.