Why Leverage is a Double-edged Sword

When picking what Forex broker to trade with, many people try to identify the best by looking at what the organization offers. Some look at the currency pairs that are available, while others might look at withdrawal terms and trading hours, but most, if not all traders, will look at the offered leverage before making the final selection. This should not come as a surprise to anyone – leverage is a great tool in the hands of traders, one that would allow them to make some great revenue for themselves, if they manage to make the right trade. But, many forget, that it is also a rather dangerous tool, especially in the hands of new traders who are not entirely sure about what they are doing. Is that why the EU has decided to regulate leverage, no deposit bonus offers, and other Forex industry details? In no deposit bonus explained by ForexTradingBonus, we can see clear indications as to why the benefit could have been restricted. It garners too much confusion for the traders. Another answer lies in the risky nature of the concepts. So, let us dive in and discuss why leverage is just as dangerous as it is good.

What is Leverage and how do the pros use it?

The concept of leverage is simple – when you start trading, you may borrow some money from a lender and invest it. The money that you borrow and invest is leverage. Now, when you make a return on the investment, you will be able to pay off the debt and the interest that come with it (because yes, when you borrow there is an interest rate applied to the borrow funds), while also being able to make some handsome profit for yourself. Pretty simple, right?

When you are looking at Brokers, you will often see Leverage opportunities referenced in ratios. A number like 1:100. This is the ratio of leverage and it means that you will be able to receive 100 dollars for every 1 dollar you invest. The number is different for most brokers, and the more the leverage ratio, the more money you can make off of it.

In this manner, professional traders who have access to high leverage options (1:100, 1:200, 1:400) are able to multiply their revenues by a whole lot. When they make a trade that they are very confident of, a professional trader will take the leverage offer from the broker and invest 100 of their own dollars and 10 000 of the broker’s dollars. Once their order closes, they will have made 100 times the money they expected to have made when investing 100 USD. After they pay off the broker, the trader will have made way more money than they could have hoped for without the leverage.

But with opportunity comes risk

Once you place an order with a certain leverage option, you might make money or you might actually have miscalculated the changes in the market, and end up losing money. This is when things get dangerous. If you invested 100 dollars with a leverage of 1:100, that means you borrowed 10 000 from the broker. This money will need to be returned one way or another, with interest on top. The Broker you are trading with will do everything in their power to get this loan back. This means that just because of one bad order, you are now ten thousand US dollars in debt, instead of being 100 dollars poorer.

This is where the double-edged nature of leverage comes in. A bad trade with high leverage means that you end up losing a lot of money and being in debt with the broker. The broker might provide you with some kind of repayment schedule, but the debt remains. This is why professional traders are very careful when they trade with leverage and only use it to its full potential when they are confident of their actions. This is also why beginner traders are advised to stay away from high leverage trades. Beginners and intermediate level traders are all more likely to make bad trades and lose money. When you add leveraged funds on top of that, beginners might end up losing a lot more money.

Regulation to protect traders

This is why the EU has introduced regulations that limit the amount of leverage that brokers can offer to traders who are not certified as being professional. The maximum leverage that a trader has access to with European brokers is 1:30. This way, the trader is protected from making trades that would result in their financial ruin. The regulation also includes limits on no deposit bonuses and who qualifies as a professional trader. These regulations are imposed by the EU to protect beginners from the dangers of the Forex industry. If the regulation does not apply to you, since you are not a resident of the EU, then you should learn to remain safe on your own. Educate yourself about the industry and learn why attractive things like Leverage may actually be dangerous. Watch out for complex Forex concepts that might seem beneficial, but bear big risks that could get in the way of your successful trading. Be smart about how you trade.