Leverage

2024 Author: Howard Calhoun | [email protected]. Last modified: 2023-12-17 10:16

As you know, Forex trading requires certain investments. Often, novice investors have a reasonable question: “How much money should be deposited into the account for normal trading?” When buying or selling any currency pair, in each application, you must specify the number of monetary units (volume) that will be involved in the upcoming trade transaction. This volume is measured in lots. 1 lot is usually equal to 100,000 units (for InstaForex broker it is 10,000). The minimum volume for a trading operation is 0.01 lots. If the current euro/dollar exchange rate is 1.29 (and forecast it should grow a little), then to buy 0.01 lot you will need an amount of 1.29100,0000.01=1290 dollars.

Are there many traders who have an initial deposit in their account that exceeds $1,000? The answer is obvious. And therefore, all brokers offer to use leverage when opening an account, i.e. the ability to trade with a larger amount than the one on the deposit. The trader has the right to choose the size of this leverage at his own discretion. On average itfluctuates in the range of 1:20 - 1:500, and for some brokers this parameter can even reach 1:1000.

Forex without leverage is in principle possible, but this option is good only for those who adhere to a conservative trading style and have relatively large funds for financial activities. And the vast majority of traders need leverage, because without it they would not be able to work in this highly profitable market.

There is an opinion among many investors that the leverage of a trading account is directly related to the risk of losing savings: the larger the leverage, the greater the risk. This is true, but only in part. In order to clearly explain what leverage is in Forex, consider the following example. Let's say we have two accounts with the same amount of initial capital ($1,000), but with different parameters: account 1 has a leverage of 1:100, and account 2 has a leverage of 1:500.

We are 99% sure that EURUSD will rise by 50 pips in the near future and we want to buy the maximum volume at the rate of 1, 2980. On the first account, we can buy 1000 x 100 / 1, 2980=77041, 6 or 0, 77 lots. In this case, an increase in the rate by 0.0001 would mean an increase in our capital by 10 x 0.77=$7.7 (1 pip for 1 lot of EURUSD equals $10). If the rate rises to 1.31, we get (1.31-1.2980) x 10,000 x 10 x 0.77=$924. Our deposit has almost doubled.

On the second account, the maximum volume will be 1000 x 500 / 1.298=385208 units or 3.85lot. An increase in price by 1 point will bring 38.5 dollars, if this deal is closed at a rate of 1.31, then the profit will be (1.31-1.2980) x 10,000 x 10 x 3.85=4620 dollars. It turns out that the deposit has increased almost five times! Impressive, isn't it?

However, a trader cannot always correctly predict the future movement of the rate, and here a large leverage can play a cruel joke - just about 25 points in the opposite direction will almost completely destroy the initial deposit. Indeed, in this case, the losses will be 3.85 x 10 x 25=962.5 dollars. In such situations, the broker forcibly closes a losing trade, and no prayers will help return the lost money.

If we open positions with the same volume on our two accounts (for example, 0, 1 lot), then the risk in both cases will be the same, and leverage will not affect either the amount of profit or the amount of possible loss.

What conclusion follows from this? Both large and small leverage have their advantages. A large leverage is useful when participating in contests and good for scalping, while a small one will make trading more comfortable and reduce the risk of large losses. Beginners are usually advised to use 1:100 or 1:200. If you want to trade with the maximum possible leverage, in the case of real trading, when "hard-earned" (hard-earned) money is at stake, never use the maximum volume in operations, otherwise you will soon have to save money again to replenish your account.