The concept of leverage has been used as a
means of increasing the potential return on investments using options, futures,
or margin accounts. In the foreign exchange market, leverage is used in very
much the same way. Investors use leverage to profit from changes in the
exchange rates between two different countries. In the foreign exchange market,
rates fluctuate relative to one another, as they are always quoted in pairs.
Leverage in FX allows traders to place trades with small amounts of capital,
known as margin. In the foreign exchange market, leverage has become the norm.
Upon opening an account with a broker, the broker will provide a certain amount
of leverage, which may be 100:1, 200:1, or 500:1 depending on the broker and
size of the buying position. Leverage on the foreign exchange market is likened
to a double-edged sword, as it has the potential to magnify both potential
profits and losses. Here are some strategies that can help to mitigate losses
and reduce risks associated with highly leveraged positions:
Goals & Cap Your Losses
While attempting to turn a profit over the
long term, many beginner traders forget to find ways of mitigating their
losses. Keeping your losses within a manageable limit is a good strategy that
can help you aim for sustainable profits rather than large upswings and
downswings. Taking substantial losses can drastically hurt one’s equity.
Investing in the foreign exchange market involves a high degree of risk, which
is only magnified with high amounts of leverage.
Setting stops is one of the most important
things successful Forex traders do to manage risk and maximize their
profitability. By setting stops, a trader can input the amount of risk and
reward that they are willing to incur on each transaction. Investors can set
static stops or manually monitor the price of the currency themselves. Setting
stops allows investors to mitigate their losses when they are wrong and
capitalize on them when they are correct. The best and most successful traders
are astute managers of risk.
More Suitable Leverage Ratio
Some new investors believe that since they
are eligible to receive 500:1 leverage, this means that they should, or have to.
In some cases, using 50:1 leverage could put you in serious financial jeopardy.
Use an amount of leverage that is more suited to your comfort level. Remember,
you should be investing with riskable capital and not funds that you cannot
afford to lose. Using a 100:1 level of leverage may still be able to help you
achieve your investment objectives.
It is very important for investors to be
careful when trading using high amounts of leverage on the FX. There is a high
degree of risk associated with it and thus a high potential for profits as
well. While generating big profits without putting up a large sum of money may
sound tempting, it is important to manage risk in such a way that traders can achieve
long-term sustainable profits.