Devil #7: Over-Leveraging

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Leverage in the forex market is the most confusing and the least understood concept as there are two different terms in the world of forex leverage which many traders ignore. These are “Account leverage” and “Real leverage.” Let us understand the difference between these leverages with an example:

Suppose you have $10,000 in your forex account, and by default, the account leverage is fixed at 100:1. This means the broker will block $100 as margin for a lot of $10,000. Now, if you want you can easily open 100 standard lots, but you decide to open ten lots which mean $10,000 x 10 = $1,00,000!

Now, if we calculate your real leverage, it would come out to be 10:1. Why? Because you put in $10,000 and your trade size is just $1,00,000 which is just ten times of 10,000. So, 10:1 is your real leverage, but initially, you started with 100:1 which was your account leverage.

It is very important to understand the account leverage and the real leverage as otherwise, you may face disappointments in your trading career.

Now, let us get into some depth…

Check out the following table:

Real Leverage Price Change in Market (%) Price Change in Account (%)
100:1 1% 100%
50:1 1% 50%
33:1 1% 33%
20:1 1% 20%
10:1 1% 10%
3:1 1% 3%
1:1 1% 1%

When your real leverage is 33:1, this means your position in dollars is 33 times the amount in your forex account. So when the market moves 1% which means 100 pips, your account value fluctuates 33%. It is important to consider the real leverage as this is the thing that makes real profits. And it is normal for a currency to fluctuate 100 pips in a day. We are talking this when the markets are moving in your favor.

Now, what when the trader’s analysis and strategies do not work? And the price of the currency pair falls 100 pips! The results are frightening. Let’s have a look at the following table to get an idea about the results if we do not use the facility of leverage with caution:

Loss of Capital (%) Return on Remaining Capital Required to Get Back to Break-even (%)
10 11
20 25
30 43
40 67
50 100
60 150
70 233
80 400
90 900

So, according to the table, if you lost your 50% of capital, then to get back to the starting point with the same amount of money which was in the beginning, you have to double your remaining money! And believe me, this is not easy.

Traders think that leveraging is the best facility in their account as they can make big profits just by risking a small amount of money, but they fail to understand that the loss is as frightening as the excitement in a leveraged position.

So, what is the solution?

The best solution is to not to disturb this devil and remain away from it. But if you still want to wet your feet by leveraging, make sure to take highly calculative decisions and open a position only after reviewing the strategy n number of times.

Closing Thoughts

Investing in the forex market is not a child’s play; it is a serious business. If you master it correctly, this world has a lot of rewards, but if you fall a victim, this world has a lot of devils.

The best way is to start reading the books of successful investors and financial newspapers to collect knowledge. Search for the experts and take their advice. Follow your knowledge and brain to create a strategy that oscillates with your accumulated knowledge.

It is not a day or a week or a month or a year task to master the strategies of the forex market. It can take years, even a decade to search for that pulse of the market that when you tingle, the Bucks fall in your account.

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