Nathan Navachi

The Problems With Leverage In a Live Currency Trading Environment

Leveraging your money can be a great thing, but it can also lead to excessively risky trading. Certainly using leverage in any business context is the key to large profits, but at what cost are you willing to achieve this? Are you willing to risk over 20% of your forex account balance on a single trade? If you answered yes, then what you are doing is less like trading and more like gambling.

One of the most proclaimed benefits of trading in the foreign exchange market is the ability to trade with anywhere from double to 400 times your account balance using leverage. Most forex brokers may or may not realize that by offering this kind of excessive magnified buying power to an inexperienced trader, it is like giving them more rope to hang themselves with.

Leveraging your money can be a great thing, but it can also lead to excessively risky trading. Certainly using leverage in any business context is the key to large profits, but at what cost are you willing to achieve this? Are you willing to risk over 20% of your forex account balance on a single trade? If you answered yes, then what you are doing is less like trading and more like gambling, and you will find that you will quickly join the over 95% of novice traders that end up running their account balance down to a margin call.

One of the main pitfalls of trading a highly leveraged position is that a trader can be forced to exit the market at the worst time possible, thus preventing any chance of a market correction that can result in hitting the profit target instead of being stopped out. Take a look at a normal candlestick chart of price data and you will notice that the long 'wicks' on either the top or bottom of a candlestick is indicative of a whipsaw in price movement.

When trading a position with proper risk management calculations in place, you can afford to let any significant downturn in the market run its course with the hope of a reversal. If however you are highly leveraged in your position then there is much less room for regular market activity and the sting of any loss will be much greater.

Another pitfall of trading with too much leverage in forex is that it will not only magnify your profits and losses, but it will also magnify the emotions you experience as a result of market movement. The fear that you experience when the market moves 20 pips against you is exactly 10 times greater when you are risking 30% of your account balance on a single trade instead of 3%.

A third reason that excessive leverage in forex can be disastrous is that the amount that the spread cuts into your account balance is greatly magnified. Even if you are trading a major currency pair such as USD/JPY that has a spread of 3 pips, trading five lots on an account that has only $7,000 can result in a loss of $150 before the market has even moved at all. This once again will magnify the emotions that you experience and can lead to trading subjectively and deviating from your trading strategy.

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