Leverage is not just available in CFD trading but also in other financial markets such as stocks, indices, and Forex. All these markets have different levels of volatility. Because of that, leverage is made limited to a smaller capital. Moreover, the rate of leverage also varies according to the kind of trade that you are in, which can either be professional or retail. The most common leverage rate of retail Forex traders is about 30:1 and 500:1 for those professional clients. It is true that professional clients are given the advantage of higher leverage, but they also need to meet some criteria which ought to be so strict. Once they pass eligibility, they will enjoy the benefits.
Knowing all these things, you will think that leverage is so appealing and a major tool of trading. But, you must consider that leverage can mirror your gains but is also capable of mirroring your losses. You can multiply your losses in leverage as easily as you multiple the gains.
What does leverage trading mean?
The question among newbies – what is leverage trading? It is the ratio of the margin amount that determines the trading position that will be placed. Before you deal with leverage, it is important to understand both margin and leverage first just to avoid confusion. If leverage is the ratio, the margin is the amount that a trader needs to deposit to be able to open a trading position.
Traders relying on short-term price movements will most likely adopt trading on leverage. This won’t be very suitable for traders who are choosing to trade long-term. Although leverage is good for your trading, it is a double-blade sword that can bring gains and losses as well. Very high leverage may lead to your margin getting wiped out easily. Remember that an increase in leverage is also an increase in risks. This is particularly true among novice traders who tend to aim for a get-rich-quick scheme. The best advice is to take on lower leverage for your trades because this will mean that your capital won’t easily get wiped out in case mistakes arise.
How Leverage Works
For starters, it is highly advisable to start with lower leverage and gradually increase it only if you gain some experience in trading. This will be the best way of keeping your position open even if negative things happen.
For instance, the maximum leverage of the trader is 10:1. He opens a trading position with $10,000 on his trading account. Because the trader is using leverage, he will have the capacity to have an asset value worth $100,000. This also means that a small 1% price movement will totally blow your account.
But if you reduce your trading position to 5:1 with a leverage amount of $10,000, you can open a position worth $50,000. With the 1% price movement, you will only lose $500. For this reason, you need to have low leverage trading to avoid losing a lot of money, or blow your account including the capital amount you invested.