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How To Benefit From Leverage
Leverage is a tool some brokers provide their traders in order to allow them to generate profits far greater than the capital at their disposal would otherwise allow. Brokers offer leverage for two reasons; the first is because they want to provide their traders with optimal conditions for maximizing profits, the second is that trading larger sums also mean higher commissions.
Leverage is a very powerful trading aid, it allows for multiplying profits several times over. But using leverage does not go without inherent risks, in the following paragraphs you'll find useful information which will help you benefit from the advantages of leverage while best avoiding the risks involved.
It's All About Trading Larger Sums Than You Actually Posses
The way leverage work is simple, using it allows you to invest sums which are much greater than the capital you actually have at your disposal. This causes the profits generated to grow accordingly.For instance, if you have just 1,000 U.S dollars in your trading account and have identified an opportunity to make an investment which will yield a 5% profit, investing the whole sum will enable you to make a profit of 50 U.S Dollars. Leverage of 20 allows you to use the same 1,000 U.S dollars as if they were 20,000 U.S dollars, a 5% profit will mean that you've made 1,000 U.S dollars, doubling your capital in just one single trade!
Different factors influence how great the leverage you can use is, you may sometimes be able to multiply the sum you can invest by 200 and even more.
Managing the Risks Involved
The down side to Forex leverage is that if the gains you've anticipated do not materialize losses you suffer may be greater than those you would have done had you not used leverage.
For instance, with the same conditions described above, if you invest just the 1,000 U.S dollars you actually have and it turns out that there was a 1% decrease in value of the product you traded on, you've suffered a 10 U.S dollar loss. If you decided to use leverage of 20 the amount you've lost is 200 U.S dollars, which is a fifth of your capital.
As shown, leverage means that if losses occur, they may be more substantial. It is therefore essential to choose carefully how and when to use leverage.
It is a good idea to use leverage when you believe the chances for gains are high. However, it is important to refrain from using leverage in a way that may cause you to suffer losses which will leave you with insufficient funds for continuing trading activities. We advise using a "stop loss" risk management strategy in order to remove any chance of such an occurrence.