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Published On: Mon, Mar 18th, 2019

How beginner traders can use leverage efficiently

The use of leverage as a trading practice has increased significantly in the last few years. Since it can enlarge both gains and losses, this strategy caused controversy among many investors, but it also gained a lot of praise from others. Read below how leverage trading works and the way you can learn to use it in your advantage!

What Leverage is and how it works

Leverage represents an amount of capital you borrow from the online broker with the purpose of increasing your chances of getting big returns by making a small investment. In other words, leverage is simply a loan provided to you by your broker that allows you to pay only a small portion of the full price for an instrument, covering the rest of it for you.

While leverage is a strategy available for any financial instrument, it is heavily-used to trade Forex, because of its low-costs and the market’s appealing price fluctuations. The requirements to use leverage typically depend on the online broker you’re trading with, but it is done through a margin account at all times.

How to Use Leverage to Your Advantage

 

  • Choose the right leverage ratio

 

To be able to use leverage, you need to open a margin account with an online broker. The amount of leverage you can get is expressed as a ratio, which is usually of 50:1, 100:1, 200:1, or even 1:30. TradeFW.com, an award-winning licensed forex broker, offers its customers the possibility to trade forex with a ratio of up to 1:30. This means you can trade up to 100k using just 3333 of your own funds! The leverage ratio also depends on the volume of the position, as well as on the region you’re trading from. For instance, in the United States, a 1:50 ratio represents the norm.

 

  • Understand the importance of a position

 

TradeFW also highlights that the leverage ratio “is measured using statistics that measure what percentage of the total capital involved in a trade represents debt (from loans) and the capacity of the borrower to meet his or her financial obligations.” Also, it emphasizes it is extremely important to know that a position represents the amount of an asset you own (currency, commodity, stock etc.) and the leverage ratio you opt for needs to correspond with the amount of time you plan to hold the position (long-term or short-term). When you open a position, keep an eye on the following level of the following features: balance (the size of your trading account), equity (the value of the account), margin (the blocked collateral), free margin (the available amount), and the margin level (the level of risk).

 

  • Understand what a margin represents

 

Whilst leverage is the amount of capital borrowed from your broker, the margin represents the amount of money you invest, the actual money you put in to fund your account – which in this context is considered the collateral. The initial margin represents the capital you use to fund your account; but in order to sustain a position; the broker requires a maintenance margin as a safety measure to ensure you don’t lose more money than you can afford.

 

  • Make risks part of your trading plan

 

So far, you’ve learned how to choose the right leverage ratio and use it efficiently. However, it is just as important to be aware of the risks and incorporate the possibility of things going wrong in your trading plan. You can start by using a lower leverage ratio, like 5:1 or 10:1, in order to get accustomed with this practice and eventually go bigger when you feel comfortable enough. Leverage can be a game-changer, but also in a negative way. Using strategic orders (stop-loss, take profit, trailing stop order etc.) can save you! Create a risk management plan and add it to your everyday trading routine. You can include the orders we mentioned, as well as other strategies able to keep you from adding to a losing position and create an even bigger mess. While in theory sounds like something you wouldn’t do, in the heat of the moment, even a professional trader can slip without having a pre-established plan to follow in such situations.

Conclusion

Leverage trading has the possibility to bring you outstanding returns, by investing only a modest amount of money. However, being aware of the risks it carries and taking the right measures can be a life-changer. As long as you follow the above steps and find a trustworthy online broker to partner up with, the work is half done. With a few precautions, information and focus – leverage trading will always be the ideal tool to help you enjoy and profit from the most competitive financial markets to the fullest, even as a beginner.

Author: Nick Parsons

About the Author

- Outside contributors to the Dispatch are always welcome to offer their unique voices, contradictory opinions or presentation of information not included on the site.

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