Leverage – A blessing or a double-edged sword?

Leverage is probably one of the most important aspects of a Forex broker. Therefore when reviewing a broker most websites take very close attention to the maximum the company has to offer. In most cases, the more the company can offer the bigger it is. The reason is quite simple. If you enter a trade with $10,000 of your own money and the broker can offer you a 1:100 leverage it means they are capable of trusting you with $1 million of their own money. Therefore it is always best to go with the ones that can offer the largest leverage because in most cases it translates into better liquidity.

Advantages of Leverage

There are many advantages when it comes to leverage. Let’s say that you signed up with a Forex broker that offers some type of deposit bonus. In order to be able to cash out your profits, you will have to trade a similar or a larger volume that you were given. Therefore, let’s say that you were given a $1,000 bonus and you are eligible for 1:100 leverage. It means that you can enter a trade with just $10 and if it is successful your volume will immediately be equal to $1,000 and make you eligible for a withdrawal, but only for the profit of course.

Another advantage of leverage is the fact that you will not need to deposit too much of your own funds in order to enter large scale trades, potentially doubling the profits. Meaning that even if you start with a $10 account you can quickly grow it with leverage.

However, there are more disadvantages connected to leverage than advantages.

Disadvantages of Leverage

Let’s boil all of the explanation down to a small story, shall we?

Let’s say that you are a student in school and like to sell the apples from your lunch for $2, while you buy them for $1. Now let’s assume that your Father finds about your small business and offers you this deal. He will give you an extra $10 every single day for you to buy extra apples and sell them in school. The only terms he has is that at the end of the day, he needs to receive $11 back. $10 for the amount he gave you, and $1 for the service. Let’s say that everything goes well for a couple of days and you are now able to make $22 dollars every day instead of $2. $11 goes to your dad and the rest stays with you. Pretty good right? But let’s assume that you have a terrible day and you are not able to sell any of the apples.

At the end of the day, your father requests the $11, but the only thing you have are apples which can spoil easily. Your father only wants the money and nothing else. So what can you do? You’ll have to either remain in dept or cover it as quickly as possible with your own money. Furthermore, this will make future deals with your father harder.

Now imagine that those $11 are $11,000 what can you do? As you can see, leverage can be both a blessing and a curse. It can bring you large profits as well as potentially throw you into debt.

Leverage for beginners?

At this point, it is clear that a beginner should stay away from leverage until he/she learns more about the market. Thankfully some brokers have already thought of ways to deal with that problem and limit the leverage based on the account balance. Meaning that if you have only $100 you won’t get 1:100, but 1:10 instead. Furthermore, the leverage issue was so big in the EU that ESMA the local regulator forced all of the brokerages to limit their maximum leverage to 1:30 on currency pairs, no matter the account size.

Therefore takes this as a tip as well as a warning towards leverage. It is definitely a double-edged sword.

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