The Forex market is very different than most other types of investing and relies on the small incremental movements in the price of a currency to generate profits for investors. Because these changes can happen in tiny fractions, you’ll need to control a very large lot of a particular currency pair to realize any substantial profit from your trades. Maintaining an account with the equity to cover these investments is difficult and beyond the reach of most causal investors. To help expand your investment in the Forex market, most brokers extend differing levels of leverage to help amplify your profits. This leverage acts as an investment multiplier to enable you to control a larger portion of currency than your investment can support on its own. By amplifying your actual investment, leverage allows you to substantially improve your profits on small movements in the value of your position.
Leverage Can Vary Between Brokers
The amount of leverage a brokers offers you can depend on a few different factors. Initially most brokers are very conservative with the amount of leverage they extend to new accounts and will typically increase it over time as the equity in your account increases and you have established a consistent record of trading with the broker. They may also adjust the amount of leverage extended for your trades based on the lot sizes you are purchasing. Most standard accounts require you to buy currency in lot sizes of 100,000 or larger. Many brokers are now offering smaller accounts and may let you open a mini or micro account, which feature smaller lot sizes of 10,000 and 1,000 each. These smaller accounts allow new investors to enter the Forex market with a lower initial investment and develop a trading strategy they can use as their account sizes increase. Most brokers will offer different levels of leverage with these various accounts and may also increase the leverage they offer you over time.
The Hidden Danger of Leverage
While leverage is necessary to make a sizable profit from the tiny movements in value of the Forex currency pairs, it can have a downside as well since it magnifies your losses as well as your gains. This danger can be managed by placing a stop loss order at a price somewhere below your initial investment to backstop your losses. Many new traders may miss this critical step and a sweeping decline in the value of the pair they are trading can wipe out their investment. As long as you take precautions, the negative effects of leverage can be minimized.
Even with the slight concern with magnifying losses, leverage is an overwhelming positive thing in the Forex market and necessary for any serious profit. By having the ability to expand the amount of currency you control with your investment through leverage enables you to reap a larger profit with small movements in the price. This leverage helps to make the Forex market what it is today and without it the potential for profit would be hard if not impossible to find for the small investor.
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Risk Disclosure Notice: CFD’s can put your capital at risk if used in a speculative manner.