Leverage in Forex allows increasing trading accounts values by literally allowing traders operate with virtual money. For each real dollar traders fund their accounts with, Forex brokers add more funds, increasing traders buying/selling capabilities on the currency market. A leverage of 50:1, for example, means that for each dollar invested a broker adds 50 dollars on top, making the trading account 50 times larger. Thus, funding your account with $1000 at 50:1 leverage would enable you to operate a $50 000 account.
Only traders with really large accounts may afford trading Forex without leverage. For all other traders leveraging their investments is often the only way to participate in Forex currency trading and be able to operate large trading lots while make reasonable profits from trading Forex.
What leverage does is it allows a trader to trade money they don’t possess. We may call it virtual money trading.
While it is possible to make profits with virtual money in Forex, it is absolutely impossible to lose virtual money, instead traders lose only real money they have invested or earned as a result of profitable trading.
Forex brokers offer various leverage options: from 10:1 to 500:1 today.
While experienced traders have no problems choosing the best leverage level for their trading accounts, novice traders often have difficulties selecting the right leveraging option.
There is danger in almost everything if one doesn’t know how to use it.
High leverage can be dangerous IF a trader doesn’t have basic knowledge about using it properly. That’s right, basics knowledge about leverage is just enough to keep any Forex trader away from troubles and actually stop worrying about this subject at all.
Let’s take an example.
Invested capital = $1000
Leverage 50:1
Buying/selling capability = $1000 * 50 = $50 000
This enables a trader to buy/sell a regular trading lot size of $10 000, which looks good and feels good. But is it safe?
Leverage allows to trade larger positions on the market. Larger positions mean larger profits when a trader wins a trade, but also larger losses if a trader was wrong on the trade.
In our case (with $10 000 lot size) each pip trader earns brings him $10 profit, but each pip he loses cost him -$10.
Leverage concerns are all about losses. So let’s focus on the simple math.
A normal regular situation: the market moves 20 pips against an open position and our trader loses 20 pips.
20 times $10 equals -$200.
Those $200 dollars will be subtracted from initial $1000 account balance, which will bring it to $800 now. (Buying/selling capability will now match $800 * 50 = $40 000)
What we actually have is that 1/5 of traders’ initial investment has been lost in just one trade! — a trade where conditions were moderate, e.g. losing 20 pips is not a big deal for currency trading. No need to mention that in two consecutive losing trades of -50 pips each our trader would lose the entire account, it is so quick! That’s why you may hear that traders call high leverage as “leverage the killer”.
Conclusion: one cannot trade with large virtual money having invested little real money. Highly leveraged account and high buying/selling capability doesn’t mean one should be trading away with large trading lots.
In our case, having invested 1000 dollars no matter at what leverage, a trader can only trade reasonably with a lot size of 1000 dollars (or less) where each pip would cost $1 (or less). Hence, losing 20 pips would mean losing only $20 on one trade. We advice trading with pip cost even smaller than $1 for accounts smaller than $1000.

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