The Less Known Evil of Leverage

Trading with leverage is extremely popular among Forex traders. High leverage is considered dangerous because of the risks associated with the fast moving rates and poor money management tactics practiced by the majority of inexperienced traders. Besides the well known danger of multiplying your losses, there is another evil hiding in margin leverage, which can wipe your trading account easily.

High leverage is advertised by many brokers. Some traders believe that the higher their leverage is, the faster they will become rich, and the Forex brokers that offer ridiculously high leverage are even praised. But in fact, there is a very practical and mercantile reason for the Forex brokers to offer higher leverage — higher earnings.

The higher is the leverage, the more money is paid by traders to their broker in form of the Bid/Ask spread. The value of the pip that trader wins, loses, or pays as a spread depends on the position size. Higher leverage allows traders open bigger positions. With 1:100 leverage, you need just about $1,000 to open a trade with the volume of 1 standard lot, 1 pip spread then costs $10 (for the USD quoted currency pairs). That would not be a big amount if your account had $100,000 in it, but if the total size of your trading account is just $2,000? That is 1% lost for every two trades regardless of whether they win or lose. With 1:10 leverage, a trader with $2,000 balance would not be able to trade standard lots, which would reduce the broker's earnings due to smaller position sizes involved. Without leverage, the spread payment to your broker would be minimal as the size of your trades would dwindle to micro-lots.

Remember that leverage comes with its price, which can be quite high and which is often overlooked by traders. If you want to learn trading profitably on a real account, try to use as little leverage as possible. Switch to a higher leverage value, only if you really know what you are doing. Do not try to become rich quick with the help of leverage. It will not allow you to do it.