Forex Fundamentals: Understanding Leveraged Trades

The Forex marketplace is one of the fastest growing financial sectors in the world. According to data released in 2022, there are no fewer than 14 million active traders (although this number is likely to be significantly higher). Some individuals are part-time investors, while others are involved on a full-time basis. Either way, anyone who may be considering a position will need to appreciate a handful of important principles. One of these involves the concept of leveraging. We will take a look at why this approach is embraced by some, the advantages that it can provide, and a handful of possible risks to consider.

Leveraging at a Glance

It should be made clear that leveraging is not unique to the Forex sector. Investors may apply leverages to other asset classes such as CFDs (contracts for difference), stocks, commodities, and ETFs (exchange-traded funds). The fundamentals are likewise rather straightforward.

A leverage in Forex trading involves the ability to access more capital than the initial deposit. This capital is traditionally supplied by a broker, or an online trading portal. The primary intention is to maximise one’s winnings without having to commit a substantial amount of their available funds.

A leveraged Forex trade can therefore be used by those who are not institutional investors, but still want to gain access to block sizes potentially mirroring an institutional position.

The Relationship Between Leveraging and Spread Betting

Now that leveraging should be relatively clear, another important variable to highlight involves a concept known as a “spread”. What is spread in Forex trading? A spread represents the difference between the bid (buy) and ask (sell) price of a given position at a specific time. Changes in this ratio are measured in “pips”. Calculating a Forex spread simply involves subtracting the bid from the ask price.

So, how can the spread of a Forex position potentially impact a leveraged trade? Wider spreads (positions associated with more pips between the buy and sell price) are known to generate higher profit margins. Of course, this is assuming that the trader correctly predicts the changes between a pair of currencies. This can be an attractive prospect for those who possess a fair amount of experience, or who are relatively certain about a short-term trend.

Is Leveraged Trading the Best Strategy to Employ?

It may appear as if leveraged trading on the Forex marketplace is the most effective way to generate a sizeable profit within a relatively short amount of time. This is indeed true if we assume that the position moves as expected. However, losses can also easily mount.

Let us imagine for a moment that an investor leverages substantially more than his or her initial capital outlay. If the currency pair fails to perform as expected, losses can occur. These may become even more serious if the initial spread (the disparity between the bid and ask prices) was relatively wide. Simply stated, the resulting losses could very well impact one’s overall liquidity, and hamper future investing possibilities.

Who Should Employ Leveraged Forex Trading Positions?

This is a slightly loaded question, as some individuals regularly utilise such methods. There are still some criteria that should be met well in advance. These include:

• The available capital
• The ability to meet margins stipulated by the trading platform
• The size of the trade
• The spread
• The time frame

Those who prefer to adopt a risk-averse trading philosophy are less likely to include leveraged trading within their overall strategy. Others might instead prefer to execute relatively small short-term positions, as the possible losses can be easier to manage.

Ultimately, leveraged trading should be used by those who are already familiar with Forex fundamentals. It is also important to mention that the trading platform itself may have an influence on the types of trades that can be executed, the spread sizes, and the associated margin requirements.

Another String to the Bow

To be clear, leveraged trading can be an excellent way to accrue impressive returns. It is nonetheless crucial to maintain an objective approach, and to realise that losses can and will occur from time to time. The good news is that plenty of online tutorials are available. These can be used to appreciate the finer points, to analyse typical examples, and to appreciate how such a strategy represents a single facet within the fast-paced Forex community.