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What is the leverage and how to use it

What is the leverage? Generally, traders use the leverage to generate more returns on risk capital.

If you don’t know how to use leverage in your Trading Accounts, this article can be helpful.

Generally, traders use leverage to generate more returns on risk capital. They can control much more significant amounts of trade.

Many new traders use enormous leverage because they open a micro account with only a few bucks. Leverage is the most common reason why forex traders fail.

The history of trader Jack

Jack finds a broker and opens his account to trade forex with a MetaTrader platform. He deposits $1,000, and he chooses a 1:100 leverage.

He is ready to open his first trade. He sells 0.01 lot of EURUSD. How much is 0.01 in money?

  • 1 lot                   = $100,000
  • 0.10 lot (mini lot)  = $10,000
  • 0.01 lot (micro lot)  = $1,000

With an open trade of $1,000 with a $1,000 account, has Jack invested all his money? No.

As you can see, Jack has a free margin of $988.88. What’s happen? Jack “is borrowing” money from his broker to leverage his investments.

Jack needs to guarantee only the loss with his deposited money so that he can open another trade.

He decides to open a Sell trade on EURUSD; this time, he buys $50,000.

Jack has established a position of $50,000, but with the leverage on his $1,000, he still has $442 of free margin.

Jack is pleased; with only $1,000, he bought a relatively substantial position of $50,000, making him feel like he is indeed a professional trader. He closes the platform and goes to lunch.

At 2 p.m., news impacts the EURUSD that causes it to rise. With a $50,000 position size, every pip values $50; after only 20 pips, Jack’s account is “blow up.” When Jack finishes his lunch, the broker closed his position in a margin call, signifying the end of Jack’s short career as a Foreign Exchange or “ForEx” Trader.

The lesson here is:  Choose appropriate position sizes given the amount of leverage you are granted for your account about the volatility associated with the pair or financial instrument you are trading. 

When you open an account with big leverage, scale the position sizes that you open appropriately, relative to the amount of capital you have in your account to hold the established position just in case it moves against you. Remember, Leverage works BOTH WAYS: It amplifies Gains as well as Losses. Size/Scale your Positions appropriately!

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