People who trade in stocks and foreign exchange (forex) might have often come across the term leverage. Leverage is most prominently used in the futures and the forex trading. Basically, leverage gives an investor the opportunity of maximizing his profits. However, leverage can also magnify the losses of an investor in case of a wrong trade. Although leverage is used in a lot of trades, it is most pronounced in the forex market. In fact, it is not unusual for a broker to offer leverage in the ratios of 200:1, 100:1, and 50:1 to forex traders. This is one of the prime reasons why leveraging has come to be associated with forex trading. Mentioned below are the important advantages and disadvantages of leverage in forex trading.
Potentially Larger Profits
The reason why leverages exist in a financial market is because they allow a trader to increasing the scale of their profits. For example, a trader who has just $1,000 at his disposal can trade for about $50,000 with the help of leveraging. With leverage, a lot of small investors get the opportunity of maximizing their profits when they are having a good day!
Potentially Catastrophic Losses
Well, a lot of people believe that the option of using leverage is a double-edged sword in any market. Many believe that leverage puts a trade under a lot of risk as the magnitude of loss increases on account of leverage. Brokers offer leverage to traders after taking into account the margin that the trader is able to put up. Traders who have a higher margin get a bigger shot at making the most of out a good call. However, as every trader will tell you, the chances of registering a loss are as much as the chances of registering a profit. During the times of a bad trade, leverage works against the trader and eats up a significant part of his margin.
As we mentioned before, leverage can greatly enhance the chances of achieving a higher profit, but at the same time, it can completely wipe out your margin. It is the prerogative of the trader to act prudently and decide how much leverage will work for him. It is also essential for an investor to do a thorough economic analysis of his financial state to ensure that he is not trading money he can’t afford to lose. Concluding, we hope that this article helped you in knowing the advantage and disadvantage of using leverage in forex trading.