There’s no denying the importance of leverage in opening and controlling a high notional position with a small capital. However, many traders destroy their capital because of leverage's destructive force.
They take leverage lightly or simply ignore the deadly potential of leverage altogether.
Lesson Highlights
- Due to its risky nature, financial regulators in different jurisdictions implement leverage limits to protect their respective countries' financial markets.
- Beyond its profitable opportunities, leveraging a trade exposes a trader's capital to more risks due to its amplified position.
How to Leverage Your Position
When you’re trading on margin, you’re leveraging your position. The leverage is the loan your broker lent you to access big positions and, hopefully, amplify your gains.
To leverage your position, you must find a broker that offers margin trading. Remember that not every broker in the financial market lets you trade on the margin.
There are also other country-specific regulations about margin trading, mostly about the maximum leverage their citizens can take. This way, the jurisdiction protects the market and the traders from excessive risks. Look at this chart for reference:
Jurisdiction | Max for Major Pair | Min. for Major Pairs |
United States | 50:1 | 20:1 |
Europe | 30:1 | 20:1 |
Australia | 30:1 | 30:1 |
Lastly, you should base your leverage on your account size (position size and leverage) and risk tolerance.
Assume you have a small account that costs USD 1,000 and that you went long EUR/USD with a notional position value of USD 110,000. If this is your situation, you increase the significant risks considering the snapping nature of the market. Meanwhile, too little leverage may hinder your position to get high returns.
When talking about trading with leverage, you should always be on the lookout for your risk tolerance level. You can take on a high leverage ratio if you’re confident with your trading skills and strategies.
However, if you’re new to forex trading, it’s best to minimize the risk of large losses by taking on lower leverage.
How Dangerous Is Leverage?
Leverage is the selling point of most forex brokers. While this gives the brokers more profit opportunities, it puts new traders on the cliff's edge because of its enticing concept.
It’s important to note that leverage does not only amplify potentially high returns—and new traders are often blinded to that trading truth.
Leveraging your trade also subjects your position to bigger risks because the magnified position with high value directly impacts your relatively smaller account.
Technically, there is a high chance that your losses may exceed your initial investment.
Let’s look at Brian’s trading situation to paint a better picture.
Brian has a mini account, which costs USD 5,000.
He believes the EUR/USD will rise from its current value of 1.2000. With that, he decided to go long and buy a standard lot. However, the EUR/USD exchange rate moves against his position.
He saw that the downward trend continued, so he decided to exit his position at 1.1500. The market has a 500-pip downward movement, which accounts for a loss of USD 5,000.
Considering the interest rate for the leveraged position, Brian’s loss has exceeded his initial investment, and his account balance is now negative.
Throughout this module, you’ve learned the main cause of death for forex traders. Remember that you must take margin trading and leverage seriously, or you’ll fall victim to the financial market.
