Leverage: Pros and Cons

When you start looking at FOREX trading, you will see a lot about leverage (also referred to as gearing).  Leverage is a powerful tool for any sort of wealth building, but like any tool it carries a great deal of risk.  Some FOREX brokers, including some of the most reputable ones, offer up to 400:1 leverage.  What this means is that for every dollar you have in your account, you can trade up to $400 worth of currency.  For a micro-lot of $1000 you only need $2.50 in your account.  In addition, you keep all the profits for these trades.

The downside is that you also assume all the losses for these trades.  With a micro lot's value being about $0.10 per pip, $2.50 represents 25 pips.  That is not a very large margin of error for a trade.  In fact, it usually represents white noise in the trading environment, which means your trade can be shut down before it ever has a chance to succeed.  You do not want that to happen.

Another problem with using large leverage in trades is that if you are in one trade, you may not be able to afford to enter another good trade it it presents itself.  It is always wise to have enough money in your account to safely enter one more trade, since good opportunities come and go at any time.

Finally, there is a failure rate in FOREX trading of 90% or more.  A lot of the failures happen because of poor business practices, especially under capitalization.  If you think of investing in FOREX the same way as investing in a traditional business, you will see that who ever is putting up the money for your trades has to get paid back in some manner.  In a business it is by taking a cut of the profits.  Now if you have $400 invested in your business for every $1 you have put in, how much of the profits are you going to be able to keep?  These reasons are the primary ones I recommend using significantly lower leverage even when 100, 200 or even 400:1 is offered by the broker.

So, now it's time to put my money where my mouth is.  If I advise lower leverage, what leverage levels do I use?  2:1 for a single trade, at most.  Yes, that is a simple answer.  It's also simple to figure out, although the for a single trade part is important.  For now, though, let's look at the 2:1 portion.

When I started my trading account, I had a micro account and funded it with $500.  This is half a micro-lot, so if I'm in a single trade, it's 2:1 leverage.  Until I'm up to $1000, I will not trade two lots on a single trade.  That would take me over the 2:1 ratio.  When I hit $1500, I may go up to 3:1 and so on.  Ideally, however, I would like to eventually bring myself to a 1:1 ratio, where I have $1000 in the account for ever micro-lot I trade.  This will slow down the compounding effects, but it will also lower my risk.  My plan is to do this when I am able to draw out enough money every month from my account to quit my day job while still having enough left over to grow the account.  At that point I will be financially independent, and so growing the account will be a bonus and not as much a necessity.

Now, what about the importance of for a single trade?  I often am in more than one trade at a time, and so my actual leverage is higher than 2:1.  If I'm in ten trades at the same time, which hasn't happened to date, my leverage at that point would be 20:1.  Still a far cry from the 400:1 offered.  Since I don't risk more than 150 pips on a trade, if all ten lose, then I'm out 1500 pips, less than a third of my trading account.  That's a pretty serious blow, but one I can recover from.  If I get my single trade leverage up to 1:1, 1500 pips would be just over 10% of my account size.

So, by all means make good use of leverage in your trading.  Just be aware of what leverage can do for you and don't use so much that it puts your account at serious risk.  In any trading activity, risk management and mioney management are twin keys to success.  Respect the power of leverage, and you'll do well.

Introduction

This blog, despite the way the name may sound, is about forex trading. Forex is short for Foreign Exchange, and relates to trading different currencies. Basically you buy one country's money against selling the money from another country. If the currency you buy gets more valuable in relation to the currency you sell, then you make money. If not, you lose money.

Forex trading is an investment, but one that doesn't have to take a lot of time and one that doesn't require a lot of money to start. The more you have to seed your account, the faster you could conceivably use the money you make from it to replace your current income of course. The flip side to that is, the more money you risk, the more you stand to lose if things don't go your way, and they won't all the time. Like any investment, there are risks. Managing your money is a skill as or more important than your actual trading most of the time.

So, you may be asking, "What's up with the title? What does that have to do with Forex trading?" Even if you're not I'm going to tell you. Feel free to skip ahead if you don't want to know. The scroll bar should be to your right.

My family has always enjoyed going to the horse races. No, we didn't consider it an investment strategy, it was just a fun day out. Like any group, of course, everyone had a different method to try to win, or at least break even. My grandmother was a very conservative better, and I'm told that my grandfather often used to complain that she would always pick the favorite and then bet it to show, which means she would win something if the horse chosen most likely to win the race came in first, second or third. She wouldn't win very much, but she'd get something back.

That is the essence of my forex trading, pick the winners, trade conservatively, and make sure you have enough money left in case things go wrong. I don't use huge margins, in fact my current goal is to bring my margin down as far as possible. I don't risk everything on one trade. I don't try to get in at just the point where things are starting to move, or wait until they are just about turn. I put my money on what look to be sure things, and then assume they will turn against me as soon as the opportunity presents itself.

So, that's the title, that's how it relates to Forex trading, and that's pretty much my time for this post. I future I will be putting up my methods, tracking my successes and failures and hopefulll providing some helpful tips from personal experience.

For now, I encourage you to check out some other learning resources on the net, specifically:

Babypips

Forex Indicators Guide