Leverage, in the most simple terms, is a mechanism provided by the broker which allows the trader to open bigger positions and trade with more capital.
Mistakenly, many beginners in the market consider leverage simply as a way to multiply their profits without realizing that it can also have a negative effect on your trades.
Let's take, for example, traders A and B.
Traders A and B both have a trading capital of 10,000 USD
They decide to trade on EURUSD using different leverages.
Trader A applies a leverage of 1:100 to his trade, which means he is now trading with 1,000,000 USD
If for example, he opens a buy trade when EURUSD are at 1,0055 and closes it at 1.0155, the movement is 1,000 points (100 pips), and his profit would be 10,000 USD
However, if he opens the buy position at 1.0055 and closes it at 1.0005, the movement is 500 points (50 pips), and so his losses would be 5,000 USD
If his trade is successful, he has effectively doubled his capital, but if the trade goes wrong, then he has lost almost 50% of his capital in one fell swoop.
Now let's take a look at Trader B.
Trader B applies a leverage of 1:10 to his trade, which means he is now trading with 100,000 USD
If he opens the same trade on USD at 1.0055 and closes it at 1.0155, the movement is 1,000 points (100 pips), and his profit would be 1,000 USD
However, if he opens the position at 1.0055 and closes it at 1.0005, the movement is 500 points (50 pips), and so his losses would be 500 USD
In this case, the trader made a smaller profit but also ran a lower risk.
Leverage can provide an advantage, but there needs to be a balance maintained to avoid unnecessary risk. The worst enemy of a trader is greed. Below is a table with the maximum leverage allowed for each asset:
ASSET TYPE | LEVERAGE: |
Forex | Up to 1:1000 |
Shares | 1:20 (fixed) |
Indices | 1:20 (fixed) |
Metals | 1:100 (fixed) |
Energy | 1:20 (fixed) |
Commodities | 1:20 (fixed) |
💡 Tip
If you are a beginner, it's better to start with low leverage. You can always change it later as your trading skills evolve.