Managing the risk associated to the use of leverage

Managing the risk associated to the use of leverage

Many people are dreaming of being a Forex trader because of its huge popularity and potential to earn a good amount of money. Besides, there is another reason for joining this largest currency exchange market, which is the leverage provided by brokers. This allows investors to use more money in the markets. Interestingly, every trader gets the opportunity to use it. However, many people still don’t know about that. Here, we will explain this term in brief.

What is the leverage?

It is regarded as a helpful tool for analyzing the financial industry like Forex. As a new trader in the United Kingdom, you can quickly increase the market disclosure beyond your primary investment. This means that an investor can enter a position trade for $1,000 currency at $100. It is called 10 to 1 leverage. But every beginner should know that profits and losses can be maximized with the proper utilization of the it. In an unfavorable market scenario, a newbie utilizing it may lose more investment than the amount he has as his deposit.

What is meant by leverage 10 to 1?

A leverage of 10 to 1 indicates that newbies can get disclosure to a particular notional value (also called trade size). They get ten times higher than their deposits, which is necessary to fund their trades. This is usually expressed as a ratio, and you can choose between– 10:1, 30:1, 50:1 and more.

Remember that the amount of leverage available to traders is determined by your broker. The amount also varies based on the standards open in different regions.  Look at this site and see the optimized leverage for specific trading accounts at Saxo. By knowing more about leverage, you can reduce your risk factors in trading.

Leverage in the currency market vs. the stock market

Leverage in the FX market is different than in the stock market. It is because of the major currency pairs, which are liquid and show less volatility. On the other hand, assets in the share market are comparatively volatile.

How to calculate Forex leverage?

Use the following to calculate CFD leverage –

  • The % of margin
  • Notional value

Brokers provide beginners with a % of margin so that they can determine the minimum investment required to fund their deals. Deposit and margin can be utilized interchangeably. Once a beginner has this %, he can multiply it by the trade size to determine the amount of capital needed to place a deal.

To determine the investment/equity, use this formula –

Equity/investment = % of margin x trade size

To calculate the leverage, use this formula –

Leverage = trade size / investment (or equity)

Before entering a deal, use these formulas to determine your leverage. Remember that no investor should deposit the exact amount of dollars as calculated by the formula. Beware of margin calls. Therefore, try to deposit a little more than the found value. Another thing to keep in mind that using this while dealing can be responsible for greater loss. In that case, rookies must learn about the ways to handle the possible risks related to it.

How to manage leverage risk in Forex

Some professionals call leverage a double-edged sword as it provides both negative and positive results. Since there is a negative possibility, we recommend adopting the risk management plan to handle it. Risking about 1% of the investment on a single trade is better but make sure you don’t exceed 5%. Successful traders always analyze the risk to reward ratio so that these guys can win a greater proportion of their deals.

No matter what happens, try to avoid mistakes while using this. Always use the stop-loss limit while dealing with it because the limit will eliminate the negative slippage. Many experts suggest that the leverage should be 10%, and if it possible to do so, reduce the percentage.