Even though technology innovation had been the main engine driving an increasing number of retail traders into the FX market, the increased use of leverage had an important role as well. Since it enables traders to trade larger volumes, even people with limited capital have access to the market. Whether it’s for FX, stocks, crypto, ETFs, or commodities, leveraged trading can play a defining role in a trader’s performance, which is why an in-depth analysis of its importance is required.
Advantages of using leverage
The main advantage of using leverage is that it enables traders to open bigger positions, by depositing only a fraction of the capital needed, in their trading accounts. At the same time, they don’t have to pay for the entire order price and thus hold a higher available account margin. This is very important, given that markets move up and down, and even winning trades can stay in the negative before posting returns.
With leverage or margin trading, profits can be levered up, but so do losses, as we’re about to see in the section dedicated to the downsides of using leverage. What traders need to understand is that leverage is only a tool and because of that, it requires proper usage methods to benefits from its advantages.
Downsides in dealing with leverage
Responsible individuals interested in forex trading must, however, be fully aware that leverage also carries risk. Even though margin trading had facilitated broader access to the financial markets and propped up daily trading volumes, without a proper trading plan and effective risk management rules, it can work against the trader’s interest.
At the same time, trading accuracy plays a key role. Given leverage can increase both the potential loss, not just the profit, traders must develop methods to open trades as optimally as possible. That means they must find key support and resistance levels and place trades around them. In doing so, they increase the probability of being right and anticipating the next market move.
Using leverage with proper risk management rules
Considering the downsides mentioned above, the use of leverage must be accompanied by proper risk management rules. Professional FX traders take the risk into account first, and only then the potential for profit. Managing risk means setting and keeping track of the percentage of the account at risk per trade, the ratio between risk and reward (risk/reward ratio), and the trading accuracy over a given period.
Even the best traders can be wrong sometimes and their safety net comes from proper risk management practices. The proper use of leverage is conditioned by implementing risk management rules and being disciplined constantly.
The bottom line, though, is that leverage continues to be a very important factor for FX traders and as a result, proper usage methods must still be in place to benefit from its advantages, while reducing the negative impacts, when they occur. What’s your opinion about trading with leverage and what experiences did you have so far when trading FX? Share your comments below!