In this episode of Truth About FX, Walter takes you to the core of leverage: what it is and how it really works. He talks about the difference between stock trading and forex trading and the use of leverage on both types of tradings.
You will also learn here how you can “fire up” an account using leverage.
Download (Duration: 03:38 / 4.17 MB)
In This Episode:
00:36 – forex versus stocks
01:06 – margin trading
01:34 – is leverage a bad thing?
03:27 – a high leverage instrument
Hugh: Hi, Walter! What is leverage and how do I know if I’m using too much?
Walter: What a great question. This is essentially how it works: forex trading is really different to trading stocks because it’s highly leveraged. The reason why it’s highly leveraged is that the market only moves a fraction of a cent. Maybe at the most is a cent or two everyday.
Obviously, when you’re talking about stocks, stocks move a lot faster than that. You can buy stocks with leverage which is what they’re calling “margin trading”. Maybe like if you put up a fifty thousand USD, your broker might allow you to trade a hundred thousand USD from the stocks.
They might double your account size, you didn’t have to pay interest on that loan and all that but that’s sort of margin trading in the stock world.
In forex, it’s a little bit different because the small movements mean that if you’re really going to make money out of this, you need to have a huge leverage. Most of your brokers are going to be giving you — what is it in the States now? Is it fifty to one?
Hugh: Yes. Fifty to one max.
Walter: Okay, fifty to one max in the States. In other countries, you can get as much as four hundred to one, or five hundred to one probably. I’ve seen four hundred to one, I’ve heard of a five hundred to one.
People say that leverage is a bad thing because they say you’re going to blow up your account if you have high leverage. It’s not really the leverage that gets you. I mean, the way I look at leverage is like fire.
Fire can be used to cook your food so it does something good. It could be used to boil some water and kill the baddies or some bacteria or whatever and all. It can also burn your house down.
That’s really what leverage is like. It’s sort of those things were if you know how to use it, and you’re a risk averse and you’re not going gangbusters trying to really make as much as you can, then you’ll probably survive.
When people get into trouble is they just max their… They rush up their trades as high up as they can. Even if they do well for a while, start making money and start doubling their account, occasionally, they’ll run into some loser. That will knock them back down.
Psychologically, they’re in big trouble because they lost so much of their account. Even if they didn’t blow up their account, they’re at a place — psychologically — where it’s difficult to continue.
Leverage is basically where you have, say a thousand dollars and your broker allows you to trade fifty thousand dollars worth of currency.
If you have a US broker and you have a thousand dollar, let’s say you have three thousand dollars on your account and you’re going to trade, you’re going to set aside a thousand dollar for a particular trade.
The broker will leverage that thousand dollars for you and say “Okay, you’ve got a thousand dollars, I’m going to allow you trade fifty thousand dollars worth of the EUR or fifty thousand dollars worth of the AUD or whatever.”
What that means is, you can make huge gains because you’re so leveraged but, obviously, it works both ways. It can also encourage huge losses and knock your account back quite a bit if you’re not careful.
That’s really what leverage is. It’s just a loan from your broker and your broker is allowing you to trade for more money per movement in the forex markets, something because the forex market doesn’t move that much.
That’s why it’s such a high leverage instrument.
Hugh: Thanks for that. I’m sure that’ll help a lot of people.