Forex trading rests on the concept of margin trading. The basic principle here is leverage, the investment strategy of using borrowed money. Any trader, especially a beginner, should be well aware of this term, how to calculate it, and which size is preferable. These concepts directly determine a profit, which a trader gains in the short term from a difference in exchange rates of global currencies.
Leverage is money that a trader borrows from a broker against a certain security or margin. By contrast with a bank credit, a size of a margin credit can exceed a security's amount by ten or even thousand times. So, a leverage size can be, for example, 1:50, 1:100 or 1:500. What does leverage like 1:500 actually mean? This is one of the largest leverage sizes on Forex. In other words, a brokerage company can lend an amount which is 500 times bigger than a deposit size. Thus, with a deposit of merely $100 a trader is capable of making transactions as if handling $50,000.
Obviously, leverage is a helpful forex tool that enables a trader to open deals at a greater amount beyond his/her means. In case of a winning trade, a profit gained would be much higher than a trader could have generated, investing his/her own capital.
A leverage size makes a direct impact on a maximum size of a position available for opening. For instance, a trader decided to open a deal on the USD/JPY pair. We should bear in mind that a standard lot with InstaForex equals 10,000 units of a base currency. With leverage of 1:100, a security (or margin) amounts to $100 to open one lot on the USD/JPY pair. With $10,000 available in an account, a trader can open 100 lots at the most.
If a trader sets leverage of 1:500, he/she can open 500 lots on the USD/JPY pair with a smaller margin of $20. In essence, higher leverage implies more modest margin and in this case a trader can manage a bigger number of lots.
No wonder, big leverage increases a chance of boosting profits. However, the other side of the coin is that a deposit could be lost in case the right trend direction is misunderstood. How to make the right decision on leverage? A trader should consider two aspects to minimize risks and at the same time maximize hypothetical profits from trading.
Whatever leverage is set, it would be a bad idea to invest all available funds at once. Ideally, every deal should account for 1% or 2% of a deposit. Make sure you set stop loss, thus you will reduce risks drastically.
Besides, it is always possible to change a leverage size to higher or lower, depending on a preference, forex experience, and risky sentiment. So, you will be able to gain more profits.
It is up to you to choose the best!
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