How Leverage can Kill your Forex Account?
Leverage is known as artistry to utilize something which is small in value to administer something that is immense in nature. In forex trading, it emerges with the same specifications but in monetary terms, it means that with a nominal value of capital invested is controlling a huge figure in forex trading.Stock traders call this trading on margin.
Leverage is offered in the forex market so that the average investors could invest. In forex trading, no interest is charged on margin. This type of account gives you the liberty to trade when the brokers offer a margin.
Sharp on both ends:
leverage is sharp as on one hand it can benefit you but on the other, it can also destroy you. Investing in forex puts your account at stake sometimes as if you are on winning side you may get a handsome profit but if you are on the opposite side you will lose more than you invested depending on the percentage you are playing.
Best Leverage to trade:
Professionals leverage traders prefer to trade on 100:1, in the forex market this means that with $500 you can have control over for $50K is the most voted leverage value. This is not it if you are playing at this value you should have this thing in your mind that you might lose $40K as well.
Leverage and Risk:
Many of you might want to know if trading with leverage can be risk-free. Well, it all depends on the amount of leverage you are applying greater the amount greater will be a risk. Specifically, it depends upon the two factors that are the percentage of leverage and the amount of the money you are considering upon. These factors are directly proportional to the risk.
Use of leverage in the forex market:
to trade in the forex market you need to open a margin account with a forex broker the amount of leverage is to be decided by the broker depending on the size of the position the investor is trading.
The amount could be
leverage % change in account
Limits defined for leverage or maximum leverage:
It is the most permissible size of trading position allowed through a leveraged account. Here Leverage means that you snaffle finance with these you purchase securities or invest that snaffle fund. Where the leverage enhances the losses and gains on trade it also multiplies the risk of a portfolio.
How leverage is calculated:
When we talk about forex the first two things comes to our mind are profit and loss. Profit and losses are calculated using useable margin and margin plus account totals by understanding how these things are interlinked and how they work it will become easier for you to make investments keeping an overview on your profits and losses.
Mostly the forex brokers permit a very high leverage ratio, or to present it in another way they have very low margin requirements. This the reason why the losses and profits are immense in forex trading even though the genuine value of currencies themselves do not fluctuate that much, evidently not like stocks.
Margin in forex account seldom broaches as a performance bond, owing to the fact that it is not a borrowed fund but only the amount of equity required to certify that your losses can be covered.
Equity is the sum of cash and the number of unrealized profits minus the losses in your open positions.
Total equity = Cash + Open position Profits – Open position losses. Total equity shows how much margin you are left with, plus if you have open positions, total equity will fluctuate as market value changes. Though it is not a wise move to use 100% of your margin for trading or else broker may give you a margin call. In such cases, the broker will straightforwardly close out your largest money-losing positions unless the desired margin has been restored.
Whereas, Margin = 1 / Leverage or leverage = 1 / margin = 100 / margin percentage. Above cited equation shows that the leverage ratio is constructed from the notional value of the contract using base currency value, usually known as domestic currency. Generally, leverage is quoted only, since the cipher of the leverage ratio is consistently 1. The amount of leverage permitted by the broker dictates the amount of margin that you need to sustain.
Leverage effect on pip value:
A typical forex account has determined lots and pip units. A pip is the smallest amount with which a currency quote can be changed whereas a lot is the least quantity of a security that is traded. Standardly one lot is worth $100,000 on the other hand pip unit is to be stated in the amount of $0.0001 for U.S dollar related currency pairs.
Above illustrated is the most commonly used pip unit by almost all currency pairs.
Pip value is the consequence that a one pip change has on dollar value. Hence, it is essential to know that the pip value does not fluctuate based upon the value of leverage used. Comparatively the leverage amount affects pip value.
For the U.S dollar, while talking about pip value, 100 pips equal to 1 cent similarly 10,000 pips will be equivalent to $1. If we talk about the Japanese Yen this rule changes exceptionally. Yen’s value is considered so low that each pip is not eligible for a ten-thousandth of a unit but, moderately each pip is 1 percent of a Yen.
Forex Champions do play at risk but not without their homework done. Play when you believe it’s a win-win situation and you are getting more for what you have invested. Leverage in forex at a time multiplies the profit on your invested amount but carefully ponder on the pros and cons it can adversely affect your account as well which will in return takes you in the slum of liabilities. Think twice and think wise before investing with leverage in the forex trading market. The ten-thousandth part of the unit can change the whole game. Thus, no nobody knows when the tables turn. Take the calculated risk with knowledge!!!