Foreign exchange brokers offer traders leverage on their accounts that allows them to enter into larger trades at no additional cost. A $10,000 size account with 50 times leverage implies a trader has access to $500,000 in buying power to do what they wish.
It is best to read and understand a leverage guide to understand the pros and cons of trading with someone else’s capital. But it might be a necessary evil as the forex market is void of gigantic daily moves that are common in the stock market.
Ironically, the foreign exchange market is the largest and most liquid market in the world as $4 trillion worth of currencies trade hands on a daily basis.
No Leverage, No Gains
Advanced forex traders with a $10,000 account balance with no leverage can consistently make a profit day in, day out.
But without the compounding power of leverage, a $10,000 balance that earns a spectacular 15% annual return (by forex standards) will likely find their efforts to be futile. Perhaps even a complete waste of time.
Meanwhile, in the stock market universe, a 15% move for a $1 trillion valued tech’s heavyweight like Apple or Amazon can be generated in a few short days. Much larger gains can happen in hours, if not minutes.
In forex trading, a 5% daily fluctuation is considered a very large move. Much larger moves, such as the10% reaction in the British pound in reaction to the Brexit vote is a once a decade event, if not longer.
So traders need leverage. They may not like it and very few can avoid it. As such, leverage is a fact of the game and a mandatory tool to generate any sort of meaningful profit.
Leverage amounts vary from broker to broker and some may reserve their highest leverage to experienced and responsible traders only. Here is a breakdown of what is an appropriate amount of leverage for traders at different stages in their trading career.
Foolish Traders- 20 times leverage: Foolish traders are usually newcomers with zero experience and close to zero trading knowledge.
They may have been tempted to sign up for a brokerage account after watching a compelling ad or are looking to take advantage of compelling sign-up offers. Chances are likely they will blow through their account in days, if not hours.
Beginner Traders – 50 times leverage: Beginner traders likely spent time learning about trading strategies through online courses, books, or browsing YouTube videos.
They are prone to make beginner mistakes and have minimal risk management strategies. They are likely to enter into a few profitable trades and will blow out their account in weeks.
Moderate Traders – 100 times leverage: Moderate traders have spent a lot of time practicing their strategies in a paper account. They understand the importance of risk management and show discipline in quickly exiting a trade that moves in the wrong direction.
These traders will likely use their margin responsibly and wait for the once a week opportunity to go big and take advantage of a unique opportunity. The odds of success aren’t in their favor but a select few will end up making a lot of money over time.
Advanced Traders – 100 to 300 times leverage: Advanced traders have spent years studying the forex market and anything short of making $100,000 a year in profit is considered a poor year.
Advanced traders are extremely patient, knowledgeable, and disciplined.
Professional Traders – 400 times leverage and above: Professional traders are likely backed by an extremely large account balance and may not even need this level of margin.
But it is made available to professional traders to take advantage of a unique opportunity. While advanced traders are happy to make $100,000 a year, a professional trader expects to make this amount in one single trade while using accurate trading signals.
Conclusion: Recognize The Dangers Of Leverage
Some brokers might extend generous amounts of leverage to all traders and there is a good reason for them to do so.
Brokers likely invested a great amount of money into their internal risk management systems that will automatically sell out a position before a traders’ balance hits zero.
It is easy to understand how an inexperienced trader would be attracted to unusually high leverage. They might even have a gambler’s mentality that a new car or house is within reach after two or three highly leveraged trades are closed out.
For some, they might hit a jackpot and win the big prize, but for the vast majority of people, this is nothing but a dream.