What is Leverage?
Leverage is a word that may confuse people, especially if they have never used a foreign exchange. Leverage is basically defined as the ability of a trader to multiply their trades beyond what they actually earn with that initial investment. It is also a term used in the trading of contracts for difference (CFDs).
For example, the average trader may only expect to make 0.5% profit on their average trades. However, that average trader can use leverage to increase their profits by 200% or even more. By using leverage in forex trading, traders can gain 2x their profits on average.
How to Use Leverage in Forex Trading?
Leverage can be found in several of the tools and instruments available for the trading of currencies. The brokers with nasdaq listings, such as IG Group and the forex broker Oanda, can make use of leverage in their trading platform. However, brokers such as EBS, FXCM, and CHEETEC don’t make use of leverage. A trader can use leverage in some of the following instruments:
· Speculative Orders: Traders usually place speculative orders to buy or sell the same pair of currencies and simultaneously, to gain more profits. The average trader’s profit percentage is calculated by multiplying the traders profits with their risk exposure.
· Counterparty Currencies: Traders can use this tool to borrow the currencies of other people, which they have the right to use at a low price. The trader borrows the asset and uses it to make a trade with the option to sell it back in the future. This increases their profits even more.
· Exchange Traded Funds (ETFs): The trader can also use exchange traded funds to leverage their positions and to profit more. The trader can sell his future position with a higher profit and then buy the same position back from the same ETF. This will increase the profit percentage by even more.
· Options: Traders can also use options, to lever their forex positions. The trader sets a buy or sell limit on a currency and then sells his call or put options (also called out of the money calls or puts) to buy or sell the same currency in the future.
These tools and instruments will give the trader better profit percentages when trading currencies with leverage. The percentage of profits depends on the leverage tool chosen, as well as the other trading conditions such as the market location and the trader’s risk tolerance.
Wrapping – Up!
Leverage is a powerful tool that is widely used in the trading of currencies, futures, and CFDs. It is a bit complicated to use, however, but once you understand the rules and concepts, it can be quite profitable to use. What are your thoughts on leverage in forex trading? Have you used leverage in forex trading before? How do you use leverage in your trading strategy?
What’s your favorite leveraged trading tool? Do you have any questions about trading with leverage? If you have any suggestions for future articles, feel free to share them with us in the comments below.