Understanding How Leverage Works In Forex
Knowing How Leverage Works In Forex and setting a realistic goal are two key points that we must understand if we are serious about trading in the Forex market. Similar to any other business venture, we still need a solid plan that incorporates clear business strategy as it will allow us to minimize loses while at the same time consistently generate profits.
Majority of new traders have difficulty navigating their way in the market because they mistake Forex trading as an easy business to earn extra cash, but soon they find that is not the case. If you are considering trading, this article about How Leverage Works In Forex is written exclusively for you.
How Leverage Works In Forex: the definition
By definition, leverage means a borrowed fund, a concept that is largely used by both companies and investors. The only difference is how each entity applies the concept into its business plan. Companies typically use leverage to finance their corporate assets.
With leverage, companies are able to use debt financing in order to invest in their business operations; a more profitable way than to request stock to quickly raise capitals every time the need for it arises. On the other hand, investors use the term to refer to the act of levering any of their investments by using a number of instruments such as margin accounts, options, and futures in order to increase their returns.
Despite the difference in how both entities apply leverage into their business plan, the point of leverage is to reap profits. In Forex, this term can simply understand as a way for traders to generate more profits from the exchange rate fluctuations between two different currencies.
How Leverage Works In Forex: the risk
The prospect of being able to generate an impressive amount of profit without having to put down all your money may be tempting, but just like any other things in life, the prospect still comes with a risk. A good rule of thumb is that the bigger the amount of leverage you are applying on a capital, the bigger the risk that comes with it. You may double your profit or lose everything you have, no in-between about it.
Many would argue that if we did not risk it, we would never try. While the saying is true to some extent, it is worth noting that you must always take a few of these followin safety precautions before you proceed:
- Before you shoot your shot at an opportunity to double your profit, first you must learn how to properly minimize your losses. Make sure to always cap your losses right within a limit you deem manageable.
- ‘Strategic Stops’ is widely consider as one of the most important features since the Forex market works around-the-clock and there is no way you can always keep up 24 hours a week. Use it to protect your profit and cap your losses when you are away.
- Last but not least is to always use the appropriate leverage that perfectly suits your personal comfort level. If you are a cautious trader, using lower leverage level such as 5:1 or 10:1 would suffice.
With this article, hopefully you know How Leverage Works In Forex.