Leverage: a friend or an enemy?

Leverage: a friend or an enemy?

Not an uncommon question among new traders and neither among some who have already been trading for a few months. Remember, there is no shame in asking questions.

This is not primary school, we are all here for a single reason: make money. Therefore, it will be a much more enjoyable experience if we could all just help each other a bit, rather than competing for pips. Nonsense. The market is big enough for all of us.

Back to the main question. Oh yes, leverage. Wait, what is leverage?

“Leverage is the investment strategy of using borrowed money: specifically, the use of various financial instruments or borrowed capital to increase the potential return of an investment.” (Source: Investopedia)

In other words, leverage allows us to operate with a small amount to manage a much larger amount of capital, which could result in bigger gains or losses in results.

Is leverage a concept we know? Of course. It is just you don’t call it “leverage”. Think about a mortgage. When buying a property, you are leveraging yourself: you put a small amount of cash and ask the bank for the rest in other to manage a larger amount and fulfill your goals.

In the Forex market, the same tool is used to give people the chance to earn more even if they have a small capital to invest. For instance, if you are using a 1:100 leverage ratio and your account balance is $100, you are allow to trade as if you would have $10,000.

There are different leverage sizes which can vary depending on the broker you’ve chosen and your trading style and risk profile. The most common ratios out there would be 1:10 (conservative), 1:100 (moderate), 1:500 (risky), 1:1000 (highly risky).

To put it simple: once you’ve decided to operate with leverage, all your results will be amplified by the ratio of your choice. Pay attention to the word “results” as we are not only talking about gains, but also about potential losses. Keep that into mind when taking an investment decision.

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