Forex brokers south Africa lend money to traders so that they can increase their investments in the forex market. The leverage effect therefore essentially consists of borrowing money from a Forex sites in Canada to increase the return on investment. However, it also means that the trader increases the risk of losing more money.
Leverage is partly responsible for the popularity of forex trading reviews Australia , as traders can easily choose how much risk they want to take with a reduced capital inflow.
Forex brokers can afford to offer leverage, as the losses are limited to the trader’s balance (the money he has deposited to open an account). To prevent the balance of a trading account from being in deficit, brokers close a online trading uk positions if his account’s margin can no longer support losses. This is called a margin call or a stop out.
In forex trading uk , it is therefore possible to invest sums greater than the initial deposit thanks to the leverage effect, but the losses cannot exceed the account balance.
How forex leverage works
The amount of money invested in a position is determined by the size of a lot. Usually, a standard lot represents 100,000 units of the base currency trading uk (the left currency for example 100,000 euros for a EUR / USD position). Buying a EUR / USD lot at the price of 1.2500 therefore amounts to buying 100,000 euros which have a value of 125,000 dollars (100,000 * 1.2500). It is also possible to buy split lots, for example 0.10 lot = 10,000 units.
The change in the price of a online trading is expressed in “pip”, a change in one pip is equal to 0.0001. In our example of buying a EUR / USD lot, each variation of a pip represents $ 10 or the equivalent in euros for an account whose balance is in euros (0.0001 x 100,000 = $ 10). If the trade moves ten pips, the trader wins or loses $ 100 depending on the direction of the market.
The amounts invested may seem huge to retail cfd trading , but leverage solves this problem. To use leverage, a trader must have a certain amount of capital which represents the margin, this minimum amount is different depending on the broker.
With 100: 1 leverage, all you need is $ 1,000 of margin to take a position of $ 100,000, with leverage of 500: 1, the required margin is only $ 200. Note that some brokers offer leverage greater than 500: 1, but most forex trading Australia do not use leverage greater than 10: 1, as it greatly increases the risk of losing, especially if you have a small account that does not can not bear the unrealized losses.
The dangers of leverage
A common mistake of novice forex no deposit bonus traders is to use leverage without taking into account the risk depending on the amount of money available in their trading account. Leverage can destroy a trading account very quickly if not properly mastered.
For example, if a trader has a $ 1000 forex account and uses 100: 1 leverage, each move of a pip is worth $ 10. If his stop is set at ten pips from the entry point and is hit, the trader loses $ 100, or 10% of his trading account. A reasonable Forex sites Australia generally does not risk more than 3% of his account in a position if he follows strict rules of money management .
Limit the dangers with money management
If risk management rules are correctly applied, the level of leverage is not important.
Online trading Germany base their risk on a percentage of their total account balance. In other words, the risk on each trade is the same regardless of the leverage.
The trader who has a $ 1000 trading account and a ten pip stop loss can use 10: 1 leverage with a 0.10 lot position, so each pip is worth $ 1 and the risk taken on the trade is $ 10 , or only 1% of the account.
The risk should be calculated based on the account balance, position size and stop loss level.
Limiting leverage in Europe
Since August 1, 2018, ESMA has adopted intervention measures on products under Article 40 of the Markets in Financial Instruments Regulation. The leverage effect is therefore now limited for retail traders in Europe.
- 30: 1 for major currency pairs;
- 20: 1 for non-major currency pairs, gold and major indices;
- 10: 1 for products other than gold and non-major equity indices;
- 5: 1 for individual stocks and other benchmarks;
- 2: 1 for cryptocurrencies.
The impact of leverage on transaction costs
forex brokers usa make money with the spread or a commission on the trading online volume. Leverage increases the income of fx broker as traders who use high leverage increase their trading volume (and the risk of losing).
For example, if a trader opens an account with $ 1000 and decides to buy 1 EUR / USD standard lot with a spread of 2 pips, he is using 100: 1 leverage and each pip is worth $ 10. The cost of the trade is therefore $ 20 (spread of 2 pips), which already represents 2% of the account. This level is unsustainable and this is one of the reasons why traders who use leverage without considering the risk taken based on a percentage of their capital tend to lose their capital quickly.
A competent trader who follows risk management rules (eg no more than 3% on a trade) uses a maximum leverage of 10: 1 where each pip is worth $ 1. In this case the cost for each trade is $ 2, or 0.20% of the account. He can thus set his stop loss correctly so as not to exceed a risk of 3%.
Key points to remember
- Leverage is borrowing money from the broker to maximize profits.
- The size of forex trading operations is determined by lots.
- A standard lot represents 100,000 units of the base currency. For a EUR / USD lot position, each change pip results in a loss or gain of $ 10.
- In order to use leverage, trading online platforms require a minimum deposit called the margin.
- The leverage differs between brokers, a leverage of 100: 1 allows you to open a position of a standard lot with only $ 1000.
- The leverage effect greatly increases the risk of losing if the trader does not use money management rules.