Leverage is used by investors to significantly increase the returns that can be provided on an investment.
USING LEVERAGE IN TRADING
Investors use leverage to profit from the fluctuations in price movements. The leverage that is achievable in the forex market is one of the highest that investors can obtain. Leverage is activated through a loan that is provided to an investor by the broker that is handling the investor’s or trader’s account.
When a trader decides to trade CFDs or Forex, he or she must first open a margin account with a broker such as NAGA Markets. The amount by default of leverage from NAGA Markets is 30:1 (major FX pairs), even if the rest of instruments have lower leverage (higher margin requirements).
A 30:1 leverage ratio means that the minimum margin requirement for the trader is 1/30 = 3,33% of the total value of trade available as funds in the trading account.
To trade $100,000 of currency (1 lot), with a margin of 3,33%, an investor will only have to deposit $3,333 into the trading account.
Although 30:1 leverage may seem extremely risky, the risk is significantly less when you consider that currency prices usually change by less than 1% during intraday trading (trading within one day). If currencies fluctuated as much as equities, brokers would not be able to provide as much leverage.
NAGA Markets margin requirements can be found here:
HOW LEVERAGE CAN BACKFIRE
Although the ability to earn significant profits by using leverage is substantial, leverage can also work against investors. For example, if the currency underlying one of your trades moves in the opposite direction of that which you believed would happen, leverage will greatly amplify the potential losses.
HOW LEVERAGE CAN BACKFIRE
To determine the amount of effective leverage used, simply use this formula:
- Total Position Size (notional value) / Account Equity = Effective Leverage
(Notional value helps distinguish the total value of a trade from the cost of taking the trade.)
Now, let’s take a hypothetical trader and calculate the effective leverage in their account.
Let’s assume that a trader with $10,000 equity has 3 positions open:
- 20,000 short the EUR/USD
- 40,000 long the USD/CAD
- 10,000 long AUD/JPY
- The traders total position size is 70,000. (20k + 40k + 10k)
- Using the formula noted above, the trader’s effective leverage is 7 times (70,000 position size / $10,000 Account Equity = 7 times)
HOW DO I KNOW HOW MUCH LEVERAGE TO USE?
There is a relationship between leverage and its impact on your trading account. The greater the amount of effective leverage used, the greater the swings (up and down) in your account equity. The smaller the amount of leverage used, the smaller the swings (up or down) in your account equity. In our trading courses, we frequently talk about using less 3 or 4 times effective leverage.
Just because you have access to a higher amount of leverage in your account does not necessarily mean you want to use all or any portion of it. Think of it like an automobile or motorcycle. Just because the machine could run at speeds of 200 miles per hour, that does not mean you necessarily need to drive it that fast. You see, the faster you drive it, the more likely you are to get into an accident. Therefore, you are in greater risk of bodily injury driving at higher speeds and leverage is like that analogy. More leverage puts your trading account at risk.
WHY DO WE ENCOURAGE LOWER LEVERAGE USAGE?
When you use excessive leverage, a few losing trades can quickly offset many winning trades.
For these reasons, it's recommended for novice investors to start out trading conservatively. The appropriate amount of leverage for you will be based on your risk appetite. An aggressive trader may utilize effective leverage amounts closer to 3 or 4 times. More conservative traders may utilize 2 or 1 times, or even less.
To request a leverage change of your NAGA trading account, please send an email to
Modifying your account's leverage may impact your trading, resulting in a greater risk to your capital. Please note that some leverage change requests may require the closing of all open positions. Leverage changes can only be performed once every 24 hours.
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