Many profitable traders rank leverage as one of the most essential trading tools, yet it remains one of the most misunderstood concepts in forex trading. Beginners wonder about the best leverage to use in Forex, and I will try to clarify the issue, beginning with debunking the illusion that higher leverage results in higher risk. I will present facts about leverage to help Forex traders utilize high-leverage Forex brokers without facing the downsides.
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What Is the Leverage Ratio?
The leverage ratio is one of the first items to consider when deciding on the best forex leverage for your trading strategy. The leverage ratio shows how much money Forex brokers lend traders. The industry standard for major currency pairs is 1:500, which means that for $1, Forex traders can control a $500 position.
The Risks of High Leverage
Traders must understand the risks before choosing high-leverage Forex brokers.
The most notable risks of high leverage include:
- The primary risk is a lack of knowledge
- The absence of or inappropriate risk management
- A fundamental misunderstanding of the relationship between leverage and risk
- Insufficient capital
- Overtrading
- Inappropriate trading volumes
- False trading strategy
- Miscalculation of trading fees due to swap rates
- Misinformation about leverage
Using Maximum vs. Less Leverage
The best leverage to use in Forex always depends on individual circumstances. As long as traders apply appropriate risk management, their portfolio risk remains identical with 1:1 leverage or 1:3000. The difference in leverage impacts how many pips a trade can go against a trader before hitting maximum loss tolerance.
Here is an example:
- A trader has a $1,000 portfolio with a 2% risk tolerance or $20
- Regardless of the leverage settings, proper risk management will close the trade once it reaches a $20 loss
- Depending on position size, less leverage may allow a trade to move 120 pips before reaching a $20 loss versus maximum leverage at 12 pips
One item to consider is that traders with maximum leverage must use a strategy that closes all positions during the trading sessions. Those keeping overnight trades should opt for less leverage due to increased risk and magnified trading costs via swap rates.
How to Select the Right Leverage Level for Your Trading
When trading with high-leverage Forex brokers, risk management will determine leverage, followed by the trading strategy. Active day trading enables traders with an understanding of the relationship between risk management and leverage to safely opt for the maximum leverage. Everyone else must understand the aspects of leveraged trading before applying any leverage.
What Leverage Ratio is Good for Beginners?
The best leverage in Forex depends on risk management and trading strategy, as there is no golden rule. Traders without an adequate strategy should not trade, as less leverage only means they will face a total capital loss at a slower rate. The risk remains identical, regardless of leverage settings.
Tips on How to Use Leverage in Your Forex Trading
Below are my tips on using high-leverage Forex brokers. Leverage makes a tremendous difference and enables retail Forex trading.
My tips on using high-leverage Forex brokers include:
- Master trading psychology
- Understand the relationship between leverage and risk management
- Trade with sufficient capital
- Use appropriate lot sizes
- Ensure negative balance protection exists
- Never hold leveraged positions overnight
High Leverage in Forex – Pros & Cons
Traders must know the pros and cons before deciding on the best leverage to use in Forex.
The pros of using high leverage in Forex include the following:
- Ability to trade Forex
- Increased flexibility
- Magnified profit potential
- Increased capital efficiency
- Decreased capital requirements
The cons of using high leverage in Forex include the following:
- A fundamental misunderstanding of leverage
- Missing or inadequate risk management
- A flawed trading strategy
- Insufficient capital
- Overtrading
- Inappropriate trading volumes
Conclusion
Despite popular belief, higher leverage does not equal higher risk. The absence of risk management and existing risk management levels determine risk. Forex traders must understand that higher leverage will decrease the number of pips a trade can move against them before a stop-loss level should exit the position at a loss, but it does not equal an increase in risk. Holding on to losing trades beyond a certain level is not a strategy that has a high success rate, which is another often-ignored fact about leverage.
Traders must also understand the relationship between risk management and leverage, which allows them to implement appropriate risk management settings. Finally, leverage also depends on the trading strategy and asset. Therefore, before deciding on leverage, traders must understand it and master risk management.
