Can Forex Leverage Affect Profits – Guide For You

Every day, most traders trade forex and other securities with their cash. If they want to buy and sell currencies in the forex market, they need to have enough money in their account. If the trader doesn’t have enough funds for trading, they use the leverage to trade with that.

Due to limited capital, you can not make much profit when you trade without leverage. However, trading forex with leverage is not always the best practice, particularly for beginners.  As a matter of fact, a lot of forex strategies focus on how to enter and exit for a trade. 

This article will focus on how traders take the same signals yet make varying profits. It is crucial in forex trading to determine the appropriate amount of leverage. Before discussing the effect of leverage in trading, let’s define leverage first.

How Would You Define Leverage?

Leverage in forex is a technique for traders to borrow cash to get more extensive exposure to the forex market for trading. They can control larger trade sizes; therefore, leverage can bring massive profits or losses.

Leverage can magnify your gains and losses depending on the trade. If the market moves in your favor, it can give you huge profits, but if the assets go in another direction, you will lose all of your capital in no time. 

Effects Of Forex Leverage On Profits

Most of the time, traders spend finding the correct entry and exit point but still lose money at the end. It is because they use high leverages without proper strategies.  Now take a look at why too much leverage wipes the traders regularly. 

We all have listened to online forex brokers promoting how they provide  200:1 leverage or 400:1 leverage. We are just explaining that they are talking about the maximum leverage. Keep in mind that the leverage ratio relies on the margin needed by the broker. 

For instance, if a 1% leverage is required, you have 100:1 leverage. It is the maximum leverage, and then there is another leverage name, true leverage.

True Leverage     

The “ full value,” also known as the “ notional value,” of your position divided by the amount of money deposited in your trading account is true leverage. Is it difficult to understand? Huh? Let’s explain this with the help of an example. 

Let’s say you deposit $ 10000 in your trading account. You purchase one standard 100K of EUR/USD at $1.0000. The full value of your position is $100,000, and your account balance is $10,000. The true leverage will be 10:1 ($100000/$10000). Another name for true leverage is “effective leverage.”

Further, you purchase another standard lot of EUR/USD at the same rate. You still have $10000 in your account, but the full amount of your position is $200000. The true leverage is now 20:1($200000/$100000.

You’re feeling excellent, so you purchase three more standard lots of EUR/USD, again at the same price. The full amount of your position is now $500,000, and your account money is still $10,000. The true leverage is now 50:1 ($500,000 / $10,000).

Assume the broker takes a 1% margin. If you calculate,  your account balance and equity are $10,000, the Used Margin is $5,000, and the Usable Margin is $5,000. For one standard lot, each pip is worth $10. 

     Balance        Equity  Used Margin Usable Margin
    $10000    $10000    $5000      $5000

In order to receive a margin call; the price would have to move a hundred pips ($5,000 Usable Margin divided by $50/pip). It would show the price of EUR/USD would have to move from 1.0000 to .9900 – a cost change of 1%. After the margin call, your account capital would be $5,000. You devastated $5,000 or 50% of your account, and the price only moved 1%.

To comprehend the long story into short, you deposit $100,000 in your trading account instead of $10,000. You purchase just one standard lot of EUR/USD – at 1.0000. The full amount of your position is $100,000, and your account capital is $100,000. Your true leverage is 1:1.

Here’s how it shows in your trading account:

      Used Margin Usable Margin
$100000  $100000    $1000$99000

In this instance, to receive a margin call, the cost would have to move 9,900 pips ($99,000 Usable Margin divided by $10/pip). It shows the cost of EUR/USD would have to move from 1.0000 to .0100! So it is a rate change of 99% or even 100%!

Suppose you purchase nineteen more standard lots, again at the same price as the first trade. The full amount of your position is $2,000,000, and your account money is $100,000. The true leverage is 20:1. 

Balance Equity   Used MarginUsable Margin

In order to be “margin called,” the price would have to move four hundred pips ($80,000 Usable Margin divided by ($10/pip X 20 lots)). That signifies the rate of EUR/USD would have to move from $1.0000 to $0.9600 – a price change of 4%.

When the trade exited at the margin call, this is how your account would look:

BalanceEquityUsed margin  Usable Margin

You would have brought an $80,000 loss!

An $80,000 loss!

You would’ve washed out 80 percent of your account, and the rate only moved 4%!

Final Thoughts

From the article, it is clear that if the trade goes not in your favor, you can face massive losses and wipe out your trading account. The leverage allows a larger exposure to the forex market but can also affect the profits if you don’t follow the right strategies.     

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