How Leverage Works and How it Can Boost Your Trading Returns

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Newbie traders are often lured in with the talk of massive returns, thanks to the power of leverage. But what they don’t realize is that with leverage comes increased risk. For this reason, it is essential that you fully understand how leverage works before you dive into forex trading.

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In this article, we are going to explain what leverage is and how it works, so you can use it wisely when you trade.

The Definition of Leverage
The dictionary definition of leverage is: “use borrowed capital for (an investment), expecting the profits made to be greater than the interest payable.”

In essence, leverage lets you trade with borrowed capital. This means you don’t need a lot of trading capital to enjoy high returns on forex trading. Or any other trading for that matter, although most other financial instruments have lower leverages compared to forex.

The Benefits of Leverage
If you open a forex trading account with a forex broker, you will see that trades are leveraged. For example, if you have $1,000 in your trading account, you can open a position with a value of $100,000. In this instance, the leverage is 100:1.

The advantage of this is that you don’t need much money to trade. Even with relatively small amounts of trading capital, you can potentially make a large amount of money, and amateur forex traders can trade higher volumes.

Different brokers offer different leverages. 100:1 is the most common, but you will see 50:1, 200:1, and possibly higher. Different leverages require different margins. For example, if you open a 100:1 position, you’ll need 1% of the trade value in your trading account. A 400:1 margin requires a 0.25% margin.

Check with the broker you sign up to what their leverage is. Most have detailed information on this and more. For example, easyMarkets has a guide on leverage in the learning centre part of their platform. Make sure you are comfortable with how leverage works before you open any trading positions.

Managing Leverage Risk
Leverage can lead to big profits, but it’s all too easy to get carried away. Using leverage exposes you to big losses, which can easily wipe out your trading account and leave you owing money you don’t have.

The key to using leverage safely is learning how to manage the risk. Luckily, you have a few tools at your disposal.

Firstly, it is a good idea not to use more leverage than you need. However, this will depend on what style of trading you use. For example, scalp traders often use high leverage to make big returns on fast trades, but if you are a positional trader, you are more likely to use lower leverage.

Make use of the tools at your disposal, such as stop-loss orders and trailing stops. You can customize these tools to suit your needs. Practice using them in a demo account, so you are comfortable with how it all works in practice.

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