Financial leverage is one of the most frequently mentioned concepts related to Forex Trading. It is often touted as a panacea for all ills, a kind of magic wand capable of filling the trader's pockets. Myths have spread around financial leverage, some of which are false. This article sheds some light on the topic.
Financial leverage in Forex Trading
In reality, the function of financial leverage has nothing miraculous about it. In fact, it can be seen as a kind of double-edged sword. It is a tool that allows you to multiply the effect of an investment. In a nutshell, starting from a small initial investment, it is possible to move large sums. If the ratio is 1:10, and you invest 10, the gains but - be careful - also the losses, are calculated on an investment of 100.
Once you understand what leverage really is, it's possible to dispel the myths surrounding it.
Myths of financial leverage
It makes you earn a lot. It's true, in a sense, but not always. As mentioned earlier, it increases potential gains, of course, but also potential losses. In short, it is a tool that allows for greater exposure than one can afford, that's all.
The higher it is, the better. This is a myth that can be "debunked" in every respect. It is not at all true that high leverage is preferable to low leverage. If anything, the opposite is true. Moderate leverage, which allows for high gains, is preferable to disproportionate leverage. It is, after all, a matter of weighing opportunities and risks. What is the best leverage? It depends. The most prudent do not go beyond the 1:10 ratio. However, conventionally, the highest leverage among those considered "sustainable" is the one with a 1:50 ratio.
Leverage risk can be managed
It's always risky. This is also not true. Firstly, because there are leverages and leverages, as already noted. Secondly, because the trader can take actions to protect capital even if they are using leverage. The most fitting example is that of the stop loss. If a stop loss is positioned taking into account the maximum sustainable loss (which is actually always subjective), the trader exits the position and saves their "skin and money". In any case, the broker cancels the trade if the loss exceeds the deposit. Obviously, this is already a catastrophe, but in any case, a limit is placed on the expenditure of resources.
