Leverage is a technique which enables traders to 'borrow' capital in order to gain a larger exposure to a particular market, with a relatively small deposit.
It offers the potential for traders to multiply potential profits – as well as losses.
The forex market offers some of the lowest margin rates (and therefore highest leverage) that investors can obtain, making it an extremely attractive proposition to traders who like to trade using leverage.
Leveraging, which is also known as trading on margin, means you can make a profit if markets move in your favour, though you can also lose more than your initial deposit should markets move against you. This is because any profits and losses are based on the full value of the trade, and not just the deposit amount.
Forex is traded on margin, with margin rates as low as 0.20%. A margin rate of 0.20% can also be referred to as '500:1 leverage' (leverage is commonly expressed as a ratio). This means you can open a position worth up to 500 times more than the required deposit to open the trade.
As much as leveraging can be seen as a way to increase your profit, it also magnifies your risk. For that reason, having a good risk-management strategy in place is essential for forex traders using leverage. Forex providers usually provide key risk management tools such as stop-loss orders, which can help traders to manage risk more effectively.
A stop-loss order aims to limit your losses in an unfavourable market by closing you out of a trade that moves against you, by specifying a price that you would like to have the trade closed at. You are essentially specifying the amount you are willing to risk on the trade.
A take-profit order works in the same way as a limit order, in that it’s always executed at the target price you specify. Where the market for any product opens at a more favourable price than your target price, your order will be executed at the better level, passing on any positive slippage.
A trailing stop-loss is a cross between a stop-loss and a take-profit order. It aims to limit your losses when the market moves against you; however, when the market moves in your favour, the stop-loss moves with it, aiming to secure any favourable movement in price.
Guaranteed stop-loss order (GSLOs) work in a similar way to stop-loss orders, with the main difference being that a GSLO has the effect of placing an absolute limit on your potential losses on a particular trade, as it ensures that your trade is closed at the price you specify. For this benefit, there is a charge in the form of a premium that is payable on execution of your order. This charge is displayed on the order ticket.
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