Leverage In Forex Trading Must Be Respected

One of the things that I wish I knew when I started trading forex is that leverage is actually your enemy. It is a bit of a paradox when you think about it, mainly because of the fact that the leverage is typically the main reason we are initially attracted to trading currencies. After all, we normally are looking at such statements as “200% returns a week.” Having said that, we overlook a lot of the fallacies in this type of trading.

Don’t get me wrong: I love trading forex. I love trading anything to be honest. However, forex is special because of the leverage itself. Currencies will typically move less than 1% during the day, and that makes it very hard to make money without leverage. In order to make any real money on a 0.15% move in the euro, you would have to have a large amount of money to take advantage of that if you were not using leverage.

However, this isn’t an excuse to use 500:1 leverage or whatever. After all, you get the opportunity to make large gains with little money, but at the same time you also have the opportunity to have massive losses. Nobody seems to focus on that, and that is why so many traders fail. By dialing down the leverage, you have the opportunity to not only stay in the game longer, but each trade longer. The ones that really run in your favor over the longer term are the ones that make you serious money. If you are over levered, a small move can wipe you out. And small moves happen 24 hours a day. You need to be able to stay in the game in order to win it.

Let’s take a look at a couple of scenarios:

You are leveraged at a reasonable rate, say 10:1 like the professional traders in the banking sector tend to be. Because of this, you earn a reasonable 11% gain over the course of the year. You start out with $5,000 in your account. Looking at the next 20 years, you will end up with $40,311.56 in your account, before takes. You have increased your account eightfold without taking major risks.

In the next scenario, you are highly leveraged. You are using 100:1 leverage, and start out with the same $5,000 in your account. Let’s assume that you are getting a “reasonable” return of 50% a year. This isn’t even as high as some of the advertisers will tell you is possible. That same $5,000 is now worth $16,626,284 at this rate in 20 years. Let me ask you this: If someone told you that they could take $5,000 of your money, invest it, and turn it into $16.6 million in twenty years, would you believe them? This falls under the category of “If it is too good to be true, it probably is.” If you get a 200% return each week as some people suggest, at the end of 5 weeks you will have already made your first million. Not likely is it?

Because of this, I would highly encourage you to look at things from a logical standpoint. By being realistic and understanding that forex is leveraged and needs to be treated with respect, you can make a lot of money, but need to be careful. If you take the highly leveraged route and trade with massive sizes, you will lose in the end. It is a zero-sum game, meaning that for every dollar that someone loses, someone else takes it. You have to be in it to win it.