Often presented as the responsible for the losses of beginner investors, especially on the Forex, the leverage is actually a double-edged tool that can allow you to increase your earnings tenfold. So how to master the leverage to make it an ally? But first of all, what is leverage exactly and how does it work?
What is the Lever Effect? Definition
Theleverage stock market is a tool that allows the trader to increase its investment capacity by mobilizing only a portion of its total capital.
Concretely, thanks to the leverage, you can open positions up to 1 000 times the value of your capital.
How Does the Lever Effect Work? Example
Leverage is noted as: 1 leverage: 50 or 1 leverage: 100, for example.
A leverage of 100 (1: 100) means that for a capital of 100 euros, you have the opportunity to trade for an amount of 10 000 euros.
This is an undeniable advantage and, although it is possible to trade without leverage, many traders prefer to take risks and see their earnings potentially increased.
Which Financial Instruments are Characterized by the Use of Financial Leverage Effect?
Leveraged trading is practiced in many markets, such as equities, Forex, commodities, indices and bonds. Forex leverage, for example, can go up to 1: 500 depending on the brokers.
Similarly, there is more than one leveraged product. They include futures, futures, currencies, CFDs and options.
Forex and Leverage Effect: Calculation
Forex is typically a highly leveraged market. Indeed, on the Forex market, we trade lots. Knowing that a Forex lot is worth 100 000 currency units, for example 100 000 euros, the particular trader resorts to either mini lots or micro lots, or to trading with leverage.
To fully understand the Forex leverage, let's take the following example. With 1 000 euros on its trading account, an investor can not trade an entire Forex lot. If he decides to use 1: 500 leverage, he can then take positions with a total value of 500 000 euros, which is 500 times the value of his capital.
The maximum Forex leverage varies depending on your broker. It can go up to 1: 500, for example at Admiral Markets, regulated broker FCA .
Which Leverage Effect to choose?
While it is easy to understand how to use leverage on the stock market to multiply its earnings, it is more difficult to determine what leverage to choose.
Indeed, even if one can estimate that the longer a position, the lower the leverage, the better leverage will always depend on your trading strategy.
For example, a position trader usually chooses a leverage from 1: 5 to 1: 20. The scalper prefers a higher leverage, from 1: 50 to 1: 500.
To limit the risks, it is advisable to always train and test your strategy on a demo account before investing in real mode. A demo trading account allows you to trade at real market conditions but with fictitious capital, so without taking any risk.
Conclusion: Risks and Benefits of the Lever Effect
To conclude on the notion of leverage in trading, it is important to emphasize its intrinsic double nature. Indeed, the leverage is a great tool that allows the trader to invest more by immobilizing less capital. However, it should be kept in mind that your winnings, but also your losses, are calculated on the basis of the total value of your position and not on the basis of the amount you actually invested. That's why you can lose more than your starting bet and why it's important to never invest more than you can afford to lose.