Understanding the concept of leverage is essential in trade forex for anyone wishing to trade forex in a highly successful manner. Historically, commercial banks have been the primary participants in the forex industry, with most of their dealers operating on a very short-term “spot” (“now”) basis. This has lead to the development of using very high debt levels to support very quick “day trading” positions and allowing retail accounts to have the same high levels of debt financing (“leverage”). Unfortunately, no one put a “day trade only” sign on these high leverage ratios. So, the public has been allowed to think that you can successful use high leverage ratios for trade forex trading positions that last longer than 1 hour, etc., when nothing could be further from the truth.
When you have a 200:1 leverage ratio, it only takes a 50 pip move to wipe out your cash position. When you have a 100:1 leverage ratio, it only takes a 100 pip move to wipe out your cash position. The AUD/USD moves about 75 pips/day.
Can Leverage Help You Trade Forex?
One of the most unique aspects of forex trading is the very liberal leveraging policies that most trading accounts have. Outside of the US, Canada, Japan and Singapore, it is very common to have leverage ratios of 200:1. To give you some perspective of what this means, 200:1 means that only $1 is anchoring $200 of a trade position (or, to put it another way, if you wanted to buy a house with a 200:1 leverage ratio, you would only have to pay one-half of 1% of the value of the house in the form of a cash deposit). The net result is that you have very little money propelling a relatively huge investment – a “day traders” dream come true.
Be Careful With Leverage As You Trade Forex
Or, it can be a nightmare. Usually the agony starts with the assumption that if day traders can successfully use leverage ratios of 100:1 or 200:1, then so can anyone involved in longer-term trading. Not! The longer you’re in the market – with any kind of trade – the longer you are exposed to both systematic and non-systematic risk. And, if you either forget (or, didn’t know how) to set stop losses, then it’s only a matter of time before your initial cash deposit gets toasted and your cash pile is looking slimmer than before. Leverage is like adding gasoline to a fire. Throw on too much, for too long, and the results will not be pretty. Stick to 50:1 or lower.
Using Leverage Successfully As You Trade Forex
The weekly chart of the EUR/AUD is sporting a 1-year old “rounding bottom” – a lovely bullish pattern that you can attempt to take advantage of through highly leveraged, moving average-based, trading, off of a 5- or 15-minute chart. The reason that you only want to day trade this currency pair is that a long EUR/AUD trade is also implicitly a short AUD trade, making holding such a position relatively expensive (since Australia’s interest rates are so much higher than what’s available in the European Union). So, keep it short and sweet, making sure that you’re out of all positions before you get your beauty sleep. Use an “Awesome Oscillator” to gauge momentum and a “Know Sure Thing” oscillator for signal confirmation.