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Leverage allows individuals to trade large amounts of currency with less capital. All Forex brokers offer leverage to their customers to trade Forex, and it's not an understatement to say that the Forex industry is built on leverage.
Top Forex Brokers1 Get Started 74% of retail CFD accounts lose money
However, some in the trading community question the necessity of leverage. In this article, I will answer these questions:
What is Leverage in Forex Trading?
Can I Trade Forex Without Leverage?
Who Can Benefit from Not Using Leverage in Trading?
Why Trading with Leverage Can Be Risky
Pros & Cons of LeverageWhat is Leverage in Forex Trading?
Leverage lets individuals use less capital than the notional value of the trade. In Forex, that means using less money to control a larger amount of currency in a trade.
Let's take an example of "2:1 leverage." That leverage ratio means I need one dollar to buy two dollars worth of currencies, stocks, or whichever market I trade. If I buy $1000 worth of Apple stock on 2:1 leverage, I only need $500 to place the trade. That $500 is called the "margin." Therefore,“leveraged trading” is also called“margin trading.”
Forex leverage can range from 10:1 to 100:1 or even higher.
Let's look at an example of a EUR/USD trade with 30:1 leverage. If I buy one standard lot of EUR/USD at $1.1400, I'm buying 100,000 euros and selling US $114,000. Without leverage, I will need $114,000 in my account to place that trade. However, with 30:1 leverage, I only need $3,800 of margin (114,000 divided by 30) to place the trade.
Leverage magnifies the percentage gain or loss of a trade.
If the EUR/USD price increases by 100 pips to $1.1500, I have made $1,000. Without leverage on a standard lot, that's a 0.9% gain. With 30:1 leverage, it's a 26% gain.
Many regulators limit the amount of leverage in their countries.
For example, the European Union (EU), the UK, and Australia limit Forex leverage to 30:1 for brokers under their regulation, and US regulators limit it to 50:1 for its residents. There can be ways of getting higher leverage, but it often means using brokers not regulated in your home country, which carries risks. The best Forex brokers for trading with high leverage will always respect their home country's regulatory requirements I Trade Forex Without Leverage?
Yes. Many brokers allow traders to request that their Forex accounts have no leverage. Here are two questions to ask when considering trading without leverage:
Is my trading account large enough to support trading without leverage? For example, to trade one standard lot of EUR/USD, if the price is $1.1000, I need $110,000 in a trading account. Similarly, to trade one mini lot (one-tenth of a standard lot), I need $11,000 in a trading account.
Can I survive trading with much smaller percentage gains without leverage? If a trade makes a 10% gain with 30:1 leverage, that gain drops to 0.33% without leverage. I must ask myself whether I can sustain my trading career with much smaller percentage gains Can Benefit from Not Using Leverage in Trading?
Traders with large account sizes. If I want to trade EUR/USD at $1.1000 without leverage, I need $110,000 for each standard lot I trade. If I want to place another trade simultaneously, for example, one standard lot of USD/CAD , I need another $100,000 for that additional trade. Trading without leverage requires much larger account sizes.
People who do not need immediate income from trading do not worry about having smaller percentage profits without leverage. These may be individuals who want to practice trading before risking real money or who have other income sources.
Someone who suffered a significant loss in their trading account and wants to get back on their feet would be better off doing it without leverage. This is an excellent reason not to use leverage because it removes additional risk. If the losing streak continues, they will not continue losing as much on their account without leverage. Removing the leverage gives them breathing room to get back on their feet. You might ask why the person doesn't switch to a demo account. The issue with demo accounts is that it removes much of the psychology from trading live accounts. I cannot cheat a live account-for example, I cannot restart a live account and tell myself that the previous result didn't count. Also, live accounts will give realistic trade fills Trading with Leverage Can Be Risky
The most significant risk is that leverage magnifies losses, not just profits. Taking the example of a one-standard-lot EUR/USD trade at $1.1400 with 30:1 leverage, the 100-pip move made $1,000 in profit from a $3,800 margin. That's a 26% return. However, if the trade went against me by 100 pips, it would have been a 26% loss. Traders often describe leverage as a“double-edged sword” because it cuts both ways-profits and losses become larger with leverage. The magnified percentage losses can lead to two problems:
Too much leverage does not allow room for losing streaks. Imagine a 2.5% loss at 10:1 leverage. If the trader suddenly uses 30:1 leverage, this becomes a 7.5% loss. Now, it does not take many such losses to halve the account size, and many traders find it difficult to recover from such a significant dip in the account value. Plenty of traders with profitable strategies lose their entire balance with a few losses because of too much leverage.
It's harder to be disciplined and have good trading psychology when leverage makes my losses larger. For example, when going through a losing streak, higher losses may cause me to make mistakes, such as taking profits too early from winning trades because I desperately need to hold on to them. Or worse still, I may move my stop loss against me because I cannot afford to lose on the trade and hope it will return to breakeven; however, I end up incurring a bigger loss & Cons of LeveragePros
Leverage lets me control a large amount of Forex with less capital, so I do not necessarily need a huge account size to begin trading Forex. Many traders would not be able to start their trading careers without leverage.
Currencies' price moves are tiny percentages against each other. Leverage allows me to magnify the size of those moves to make it worthwhile to trade Forex.
Leverage lets me place trades in more currency pairs because I need less capital or margin for each trade
Leverage magnifies the size of losses. This is the most significant risk of leverage.
Some traders use too much leverage because their account sizes are too small, and they do not survive a losing streak.
Excessive leverage makes it harder for traders to remain disciplined, especially because of the psychological effects of large drawdowns.
My Take
Leverage is one of the foundations of Forex trading, and almost all Forex brokers offer leverage to their clients. Leverage allows traders to control large amounts of currency with a smaller amount of capital, and many traders would not be able to trade without leverage. Leverage is almost necessary because many currency prices have tiny percentage movements, and leverage allows traders to magnify those movements to make the profits reasonable. However, leverage also increases risk. I am doubling my risk if I go from 10:1 leverage to 20:1 leverage. I must establish that I am profitable and can survive losing streaks before increasing leverage. Higher leverage is also psychologically harder because the account is more volatile, which can lead to more emotional trading. I am glad Forex has leverage because it allows me greater long-term profitability. I can always reduce my position sizes if I am worried about the extra risk.
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