To understand how to proceed, we need a detailed understanding of the economic and political conditions in each country, the global macro economy, and the impact of market volatility on particular markets.
But the truth is that it is not usually economic or global financial volatility that confuses people.
Instead, a lack of basic knowledge about how to use leverage is often the root cause of trading losses. According to the largest brokers, most retail forex customers are losing money.
Abuse of leverage is often blamed for these losses.
The following describes the risks of high leverage and summarizes ways to offset risky leverage levels.
Leverage is the process by which an investor borrows money to invest or buy something.
In foreign exchange trading, funds are usually obtained from brokers.
While currency traders can borrow heavily against initial margin requirements, they can earn more from successful trades.
In the past, many brokers were able to offer high leverage ratios of up to 400:1.
This means that with a deposit of 250, a trader can control about $100,000 in the global foreign exchange market.
However, financial regulations in 2010 limited the leverage offered by brokers to US traders to 50:1(still quite large).
This means that with the same $250 deposit, the trader can control $12,500.
How to Choose the Right Level of Leverage Before choosing the level of leverage, investors should review generally accepted rules.
The three simplest leverage rules are: 1. Keep leverage low; 2.
2. Use stop losses to reduce downside and protect funds;
3. Limit the capital of each position to 1% to 2% of the total trading capital.
Currency traders should choose the level of leverage they feel most comfortable with.
If you are conservative and risk-averse, or if you are still learning how to trade currencies, a lower leverage ratio (for example, 5:1 or 10:1) may be more appropriate.
Tracking or limiting stop losses provides a reliable way for investors to cut their losses if a trade goes awry.
By limiting stop losses, investors can ensure that they can continue to learn how to trade currencies, but they can limit potential losses if trades fail.
These stops are also important because they help reduce trading sentiment and allow individuals to leave the trading desk unemotionally.
Choosing the appropriate level depends on the trader’s experience, risk tolerance and comfort level in operating globally.
New traders should be familiar with terminology and be conservative in learning how to trade and gaining experience.
Using stops, keeping positions small, and limiting the amount of capital per position is a good start to learning the proper way to manage leverage.
