Leverage in forex trading

Forex broker sites UK lend money to traders so that they can increase their investments in the online trading uk market. The leverage effect therefore essentially consists of borrowing money from a broker to increase the return on investment. However, it also means that the trader increases the risk of losing more money.

Leverage is partly responsible for the popularity of online trading sa , as traders can easily choose how much risk they want to take with a reduced capital inflow.

Forex brokers usa can afford to offer leverage, as the losses are limited to the trader’s balance (the money he has deposited to open an account). To prevent the balance of a Open Forex trading account from being in deficit, brokers close a trader’s positions if his account’s margin can no longer support losses. This is called a Canadian Forex sites call or a stop out.

In forex trading, it is therefore possible to invest sums greater than the initial deposit thanks to the leverage effect, but the losses cannot exceed the account balance.

How forex leverage works

The amount of money invested in a position is determined by the size of a lot. Usually, a standard lot represents 100,000 units of the base currency (the left trading uk for example 100,000 euros for a EUR / USD position). Buying a EUR / USD lot at the price of 1.2500 therefore amounts to buying 100,000 euros which have a value of 125,000 dollars (100,000 * 1.2500). It is also possible to buy split lots, for example 0.10 lot = 10,000 units.

The change in the price of a online trading platforms is expressed in “pip”, a change in one pip is equal to 0.0001. In our example of buying a EUR / USD lot, each variation of a pip represents $ 10 or the equivalent in euros for an account whose balance is in euros (0.0001 x 100,000 = $ 10). If the trade moves ten pips, the trader wins or loses $ 100 depending on the direction of the market.

The amounts invested may seem huge to retail traders, but leverage solves this problem. To use leverage, a trader must have a certain amount of capital which represents the margin, this minimum amount is different depending on the broker.

With 100: 1 leverage, all you need is $ 1,000 of margin to take a position of $ 100,000, with leverage of 500: 1, the required margin is only $ 200. Note that some brokers offer leverage greater than 500: 1, but most professional traders do not use online trading Germany than 10: 1, as it greatly increases the risk of losing, especially if you have a small account that does not can not bear the unrealized losses.

The dangers of leverage

A common mistake of novice Canadian forex brokers traders is to use leverage without taking into account the risk depending on the amount of money available in their trading account. Leverage can destroy a trading account very quickly if not properly mastered.

For example, if a trader has a $ 1000 Forex bonus trading account and uses 100: 1 leverage, each move of a pip is worth $ 10. If his stop is set at ten pips from the entry point and is hit, the trader loses $ 100, or 10% of his trading account. A reasonable trader generally does not risk more than 3% of his account in a position if he follows strict rules of money management .

Limit the dangers with money management

If risk management rules are correctly applied, the level of leverage is not important.

Traders base their risk on a percentage of their total account balance. In other words, the risk on each trade is the same regardless of the leverage.

The trader who has a $ 1000 trading account and a ten pip stop loss can use 10: 1 leverage with a 0.10 lot position, so each pip is worth $ 1 and the risk taken on the trade is $ 10 , or only 1% of the account.

The risk should be calculated based on the account balance, position size and stop loss level.

Limiting leverage in Europe

Since August 1, 2018, ESMA has adopted intervention measures on products under Article 40 of the Markets in Financial Instruments Regulation. The leverage effect is therefore now limited for retail traders in Europe.

  • 30: 1 for major currency pairs;
  • 20: 1 for non-major currency pairs, gold and major indices;
  • 10: 1 for products other than gold and non-major equity indices;
  • 5: 1 for individual stocks and other benchmarks;
  • 2: 1 for cryptocurrencies.

The impact of leverage on transaction costs

Forex brokers make money with the spread or a commission on the Forex trading Australia  volume. Leverage increases the income of brokers, as traders who use high leverage increase their trading volume (and the risk of losing).

For example, if a trader opens an account with $ 1000 and decides to buy 1 EUR / USD standard lot with a spread of 2 pips, he is using 100: 1 leverage and each pip is worth $ 10. The cost of the trade is therefore $ 20 (spread of 2 pips), which already represents 2% of the account. This level is unsustainable and this is one of the reasons why forex Australia who use leverage without considering the risk taken based on a percentage of their capital tend to lose their capital quickly.

A competent trader who follows risk management rules (eg no more than 3% on a trade) uses a maximum leverage of 10: 1 where each pip is worth $ 1. In this case the cost for each trade is $ 2, or 0.20% of the account. He can thus set his stop loss correctly so as not to exceed a risk of 3%.

Key points to remember

  • Leverage is borrowing money from the broker to maximize profits.
  • The size of online trading Canada operations is determined by lots.
  • A standard lot represents 100,000 units of the base currency. For a EUR / USD lot position, each change pip results in a loss or gain of $ 10.
  • In order to use leverage, forex brokers require a minimum deposit called the margin.
  • The leverage differs between brokers, a leverage of 100: 1 allows you to open a standard lot position with only $ 1000.
  • The leverage effect greatly increases the risk of losing if the trader does not use money management rules.

CFDs on stocks

The process for buying Stock CFDs is similar to buying stocks with a traditional broker, but there are some important differences to consider.

No ownership – when you buy a stock, you physically own a small part of the business in question. This is not the case when you buy a CFD. You simply own a contract that is in no way tied to the stock of the company (the underlying asset), even though the price of the CFD reflects the price of the company’s stock.

Much Lower Commissions – Commissions for buying CFDs are reduced compared to the traditional stock market.

Lower Margins – Many stock brokers require a 50% margin. CFD brokers allow you to buy stocks with a margin close to 5% (and sometimes less!).

Overnight Funding Fee – Your broker may charge you a small commission for positions held overnight

CFDs on commodities

As you can see, there is no dearth of options for trading commodities with CFDs, and this is only a partial list:

You already know that CFDs are contracts that track an underlying asset, but if you are going to trade commodity CFDs you should understand the underlying product as well!

Here are the main differences to keep in mind before buying commodity CFDs versus buying the underlying product itself:

– A commodity has an expiration date that you don’t have to worry about when buying a CFD.

– If you want to enter the commodity market directly, be prepared to spend a lot of money, but CFDs can be bought with reduced expense.

– Commodities are valued in the futures market, but all contracts traded in the futures market have a different expiration date. This can be seen on price charts which show two months of information, but CFD prices are based only on the current month. If you want to base your buying and selling decisions on more complete information, in most cases you will need to obtain this information from a source other than a CFD broker.

Note: Commodity CFDs are not recommended for novice traders. You need to have a thorough understanding of the general commodities market and what you are trading indirectly before you navigate these waters!

CFDs on currencies

You’ve probably heard the term Forex sa which stands for Foreign Exchange, the forex market. Traders simultaneously buy and sell a currency to take advantage of the movement between a currency pair.

Currency trading  is fast and always on. It doesn’t happen in a centralized exchange, you can trade forex 24/7. There is no closing bell here, and fortunes can be made and lost in the blink of an eye. ‘eye. Forex trades are often short “scalping”, they can last a few hours, minutes or even seconds.

To give you an idea of ​​how much money is flowing daily in forex, the average daily turnover is $ 5,000 billion.

Here are the main currency pairs:

  • EUR | USD
  • GBP | USD
  • USD | CHF
  • USD | JPY
  • USD | CAD
  • AUD | USD
  • NZD | USD

And here are the crosses that are different from the major pairs because the US dollar is missing from the pairing entirely:

  • EUR | CHF
  • EUR | GBP
  • GBP | AUD
  • AUD | JPY

The first currency shown (on the left) in the pairing is called the base currency (also known as the primary currency), and the second is called the quote currency. Currency pairs are quoted with four or five decimal places, the fourth decimal place represents a point of variation called “Pip”. If the price of EUR to USD is 1.2200 (i.e. 1 euro = 1.2200 dollars) and it moves to 1.2201, it has risen by one pip. The prices displayed by your broker come from the biggest banks and companies on the planet which move hundreds of millions, if not billions of dollars at a time.

Forex is a highly speculative market, but it offers a few advantages:

  • It’s a market that’s always open
  • Margins are extremely low, coupled with flexible position sizes
  • Brokerage commissions are low
  • And it’s the most liquid market on the planet

There is also a major downside:

The leverage offered by brokers considerably increases the risks. In this context, a novice trader can be compared to a person who drives a sports car at full speed without a driver’s license – it passes or it breaks. (Article to read to understand the basics of forex trading south Africa  Beginner’s guide to forex trader )

CFDs on stock market indices

Stock Index CFDs are functionally quite similar to Stock CFDs, but they represent a group of stocks of companies that have one thing in common. You could say they’re all tech companies, or pharmaceutical companies, or whatever.

The Dow Jones index is made up of the 30 largest American companies, the price of the index is weighted according to the size of each of the companies that make up the index. In other words, if the majority of the stocks of the companies that make up the index increase, the value of the index also increases, and vice versa if the prices fall.

Indices automatically provide a certain diversity in an investment portfolio, but they are also useful for investing in the economy of a given country.

 

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