Forex trading is the brilliant opportunity to rake in profits in this vast world of investment and trading alternatives. It is a mine of offers that are discreet and not available in other markets. Forex leverage is one such alternative that allows you to double your profits via trading in high volumes.
What is leverage in trading?
Leverage in trading represents borrowed money that allows traders to control more significant positions with a smaller amount of actual trading funds. For example, if you have 1:100 leverage and $1000 in the account, you can control $100 000 and open more significant positions.
Can you lose money with leverage in forex?
Yes, you can lose money if you use leverage in forex and earn more. Leverage amplifies returns and amplifies loss because traders use more prominent positions. Leverage gives you the ability to risk more money during trading, but you as a trader have the opportunity to decrease risk.
Leverage is as same as a sports car. You can drive 250 km/h, but you do not need to do that all the time because you can hurt yourself.
Forex leverage can make you regret the step if not done cleverly. You can lose out on significant funds, and your account can go in a negative balance too. You will have to pay the difference to the brokers, or spending more money and lawsuits will be an ordeal since that money is what you owe them.
To avoid such a situation, keep reading to find out about the process of Forex trading and how debt is also a factor in it.
Leverages is a two-faced edifice. If done recklessly, your account may be left with zero dollars. On the other hand, however, a calculated approach can bring in tons of profit for you!
To put it simply, the broker acts as a lender and helps you in trading in high volumes but with low capital. However, it is not as easy as it sounds.
So let us answer the central question:
Can You Go Into Debt Using Leverage?
No, you can not go into debt using leverage because you do not get borrowed money into your trading account; you get the ability to control more prominent positions with a smaller amount of actual trading funds. For example, if you make a $1000 deposit, you will have $1000 in your trading account balance.
Is Forex Leverage a Loan?
Forex leverage is a notional loan. In simple words, you don’t physically receive a loan (borrowed money). For example, if you deposit $10 000 in your account and take 1:100 leverage, you will have a $10 000 balance without any loan because leverage is not a bonus. You will have only the 100x increased purchase ability.
Do I Have to Pay Back Leverage?
No, you o not need to pay back leverage because you will not get real borrowed money from your broker. You do not own borrowed money. If you deposit $5000, you will have $5000 in your account, but you will have the ability to buy $500.000 if you have 1:100 leverage.
What happens if you lose on a leveraged trade?
If you lose on a leveraged trade, your portfolio balance will decrease. However, if you lose so much money and do not meet minimum margin requirements, your broker will liquidate your assets to help assure that you don’t lose more money than you put into the account.
In simple words, if you lose money that you deposited, you will have zero dollars. There are no loans or debts in trading if you get leverage from your broker. You can lose faster your deposit money.
If you lose a position, these situations will occur:
- If your broker was prudent enough to save you from disastrous losses by setting a margin call, you are in luck. It is what curbs the position as soon as your account goes at zero. This will prevent your account from getting a negative balance and save broker expenses as well.
- Without a margin call, it can all fall apart. Usually, all brokers offer negative balance protection and set your account to zero again if you have a few dollars below zero.
Understanding forex leverage
Forex leverage brings you the opportunity to trade in larger volumes than average. The leverage is provided based on account size and trade. Therefore, if you have a high balance, you will get high leverage.
For example, if you get 50:1 forex leverage, then you are eligible for a trade of $5,000 with only a $100 balance. This is because the forex trades occur in multiples ($100,000). For example, to trade in $100,000, you only have to deposit $2,000, i.e., is 50:1 leverage.
However, your profits or losses will be by $100,000 and not $2,000. Hence, you will either win big or go home by losing all your funds and more.
The working process of leverage
Leverage is infamy called the loan to traders. However, in the forex world, it holds a slightly different meaning.
Leverage in generic terms is a credit addition. For example, when you acquire a loan to buy a house or a car, it is leverage. In the stock markets, traders get loans from brokers and pay them back once the motive is fulfilled. That is not how it goes for forex.
Forex leverage stands distinguished from other types of leverage because you are not paying the money back to anyone. It is only a safety shield to ensure you don’t default on your position. Hence, insinuating that your position will stay open until the margin closes it.
Loans are a burden because you need to pay the extra money known as interest while there is no such aspect in forex leverage or margin. However, you might have to pay the interest known as Swap for overnight positions. It is ominous that even the broker pays interest to you in certain situations.
Definition of a margin
Margin refers to the original balance in your account. This is the money that you get leverage for. Simply put, it is used as a security against your loan from the broker.
The brokers have varied margins based on the size of trade and the currency. For example, A new currency has a high margin. However, the general margin stands as follows, 2% for 50:1 leverage, 1% for 100:1 leverage, and 0.5% for 200:1 leverage.
Losing in forex leverage means losing your money and an empty account with just one swipe of bad luck. Let’s take a closer look at how it leads to more losses:
Using leverage often makes people complacent and leads them to believe that they can overpower the market. Leverage can create an illusion that you hold more control over the market. This situation is even more relevant when you have gone through a significant loss.
This situation also occurs when a person becomes too consumed with the idea of power after a winning streak. Hence, you should be very careful before any new position and avoid including emotions in the same.
Excessive use of leverage
Fore allows you to trade in higher volumes. For example, a stock trader gets 2:1 leverage while forex provides the alternative of a 100:1 leverage too. However, you should not be greedy and consume all the leverage that you can get. While these might tempt you to make high profits, they also lead to massive losses. Furthermore, many countries had to regulate this leverage cap to avoid any such losses.
The most recommended leverage amount stands at a 1:100 ratio and is even lower for beginners.
Margin call risk
If you lose out on a trade, the margin will also be reached rapidly. The amount in your account can fall to zero, and the broker will be left with the alternative for liquidating the account. This also influences the other potentially profitable positions.
Minimize your risk
Practicing risk management is the holy grail of avoiding losses in forex leverage trading—the most widely practiced one is stop-loss orders.
As the name suggests, a stop-loss order puts a bar on the risks due to forex trading. This entails placing a limit on losses. Hence, once you reach that limit, the broker will stop trading and prevent further losses.
Leverage can be beneficial if one is careful while trading with it. It is essentially a loan that you can use to gain profits, but you don’t owe any money to the lender with the eccentric quality.
However, debt is always an attached aspect of forex leverage as you never know when your account can go in the average balance. Hence, you lose more money than you invested, and now you need to pay the negative balance to the broker.