Forex Leverage: a Two-Edged Sword

As every forex broker says with pride, in the forex market you can leverage your money and make enourmous earnings. As attractive as it sounds, leverage also has a dark side, losses.

Leverage is just the ability to trade with more money than you have. If you have a leverage of 1:100, you can open a trade of $100,000 with $1,000. When the pair moves, you earn or lose 100 times this move. If the exchange rate goes just 1% in your favor, you double your money.

However, leverage is not perfect. Just like it makes profits big, it also magnifies losses. Just as a 1% move in your favor will double your investment, a move of 1% against you will erase it quickly. If the leverage is higher, and some brokers go as high as 1:500, your losses will be eliminated much faster.

When you trade or use a automated forex trading system, make sure to properly adjust your desired leverage. Don't make it too small, because you'll miss out some good opportunities. However, don't set it too high, or your losses will be greatly magnified.

Have a great trading week,
Nadav

nadavs

Short Selling

Sometimes you want to enter a trade, but you don't have the right currencies. For example, your accound is funded with US dollars, and you think the dollar is going to rise over the Euro, so you want to "sell" the EUR/USD pair, meaning selling Euros and buying dollars. However, you don't have Euros to sell.

To get over this problem, your forex broker allows you to do "short selling". This means you sell something you don't have, and you agree to buy it later. This enables you to profit when something is going down. You sell it now, at a high price, and buy it when the price is lower. "Buy low, sell high". You do exactly that, but in reverse.

This order is common also on the stock market, so people can profit from a down market. However, it is not always available, and the risks are much greater (in theory, there is an unlimited loss). Also, if the price suddenly goes up, you may not be able to buy back the stock, and you'll be left with a huge loss.

Most good forex systems "know" that short selling is possible. This way you can benefit both ways - when a currency goes up, and when it goes back down.

Hope you learned something new today.
Nadav

nadavs