What is the best leverage in forex trading?

Forex is a form of leveraged trading in which the trader is able to control a large volume of assets with a small investment. In forex trading, you are able to trade 100,000 units of a currency pair using only a few hundreds or thousands of dollars. This is possible through something called leverage in forex trading. Every forex trading platform requires traders to indicate their leverage ratio before they start trading.

What is forex leverage?

To determine what is the best leverage in forex, you should first understand what a leverage is. Leverage on forex trading refers to the amount of money that a forex broker allows you to trade with depending on the ratio of your invested capital to the borrowed funds. In simple terms, the broker lends you some money to cover majority of your trade, allowing you to open forex positions with a small capital.

For example, if you want to invest in currency assets of 100,000 units, you are required to use a large amount of capital. With leverage, the broker enables you to trade the 100,000 units using as little as $1,000. So, it is like you are borrowing a large amount of money from the broker to be able to invest in forex.

Leverage is closely related to other terms in forex trading. For instance, margin and leverage are both used to determine the amount of money the trader will use to open a position.

The best leverage in forex trading is obtained by dividing the margin requirement by the total trade value.

For example, if you want to borrow some funds from your trader to invest in one standard lot of EUR/USD, which is about 100,000 units, you may be required to have a margin of 5%. This means you are able to use $5,000 to place an order on EURUSD. The leverage ratio will then be calculated as 100,000/5,000 = 20:1.

For you to trade with the same lot size using $500, you will need a leverage ratio of 200:1. Thus, the leverage you will set depends on the amount you have deposited, the lot size, and the margin requirement of your broker. A higher margin will require smaller leverage, while lower margins will allow higher leverage ratios.

You do not need to understand all the math involved in determine the leverage ratio. What you need to understand is that with a leverage ratio of 100:1, for example, you can trade $100,000 using $1,000 only. Other common leverage ratios are:

  • 500:1
  • 400:1
  • 200:1
  • 80:1
  • 50:1
  • 20:1
  • 10:1
  • 5:1

One of the myths that we need to square out is the misinformed belief that forex brokers set high leverages to wipe out your money or protect themselves from risks. They also want you to continue trading so that they can continue earning commission and spreads.

The best leverage in forex trading magnifies your profits by ensuring that you trade in large quantities of each currency. Movements in currency prices are usually monitored in pips – small changes in the currency prices – which can be as little as 1 cent in real terms. For instance, the price of GBP/USD might increase from 1.9100 to 1.9250. In real sense, this is a change of only 1.5 cents, but in terms of pips it will be recorded as 150 pips.

Thus, currency pairs must be traded with large amounts of money for the trader to make sizeable profits. Leverage comes in handy to magnify such profits because when you are dealing with large amounts such as $100,000 you can be able to make good profits with small changes in the currency prices.

What is the best leverage ratio in forex trading?

This question has no definite answer because the amount of leverage depends on multiple parameters, including the appetite of the trader. Some amateur traders rush to place high leverages with the hope of making huge profits. Wrong move!

Leverage can give you a lot of profits, but it comes with significant risks as well. With a leverage of 400:1, a small change of currency prices in the opposite direction can stop you out. To decide on the best leverage, check your balance and equity, margin, free margin, and account level.

As a rule of thumb, smaller accounts with less than $1000 require higher leverage while bigger accounts with over $10,000 require smaller leverage ratios. There is a common finance adage that goes: risks of liquidation reduce with increased leverage. However, there are high risks of automatic liquidation if you use a high leverage.

Generally, the best leverage in forex is 100:1 because it allows the trader to take several positions while at the same time reducing their chances of a stop out. I would say that a small leverage enables newbies to survive in Forex trading.

With a high leverage, you can get a margin call or stop out easily. For an account of less than $1,000, it is better to use a leverage of 50:1, which allows you to make good profits with low lot sizes while at the same time minimizing your liquidation risks.

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