Leverage in Forex allows you to increase your profit potential even with a minimum deposit. Your $500 can become $50,000 with a 1:100 leverage. Imagine if you’re allowed to use the leverage of 1:500.
While the idea of having more funds to trade even with a small deposit sounds great, it’s important to remember that you’re basically borrowing money from your broker. You’ll need to pay it back whether you win or lose.
Despite this knowledge, some traders end up overleveraging. You might want to avoid this huge mistake if you’re to preserve your sanity and your account.
Let’s talk more about this.
What is overleveraging?
Overleveraging is when you borrow more money than you’re able to pay or beyond what your account can cover.
Traders who have a hard time removing emotions while trading often ends up making this mistake. Sometimes, the excitement of your wins can cause you to open trades outside of your plans. Without discipline or adhering to a tested strategy, you could risk your account needlessly.
How do you avoid overleveraging?
The quick answer would be not to overleverage at all. You know the risks involved if you do so it makes no sense to do it. Say your emotions got the better of you. What then?
1. Recognise and acknowledge your mistake
Chasing your losses or wanting to profit more following a win often results in making rash decisions. The moment you realise that you’re no longer following your trading plan and your decision is ruled by fear or anger, you should stop whatever it is you’re doing.
Analyse what you’re doing and walk away when you know you’re risking your account because of ego or fear.
2. Choose to play it safe all the time
It’s often said that the higher the risk the higher the profit. But there’s no need to take risk needlessly, is there? Sticking with the best leverage to ensure your account stays intact doesn’t mean you’re no risk-taker but that you’re a smart trader.
3. Always adhere to your trading plan
Regardless of the outcome of your trade, stick to the trading plan that you’ve tried and tested to be effective. Don’t deviate from it to avoid making a series of mistakes. If your strategy isn’t present, don’t push it. Wait for another trading day.
However, when your trading plan no longer works after several tries, adjust and improve. Nothing is permanent on the market.
What is considered safe leverage?
Many traders agree that the best leverage ratio is between 1:100 to 1:200 because it provides a good balance between your buying power and the level of risk you’re taking. It also allows you to open just enough trades while protecting yourself against overleveraging.
If you’re new to Forex trading, it’s recommended that you start with a 1:50 leverage, and then move up once you’ve gained enough confidence and experience in your trading skills.
Ideally, the leverage you choose should be based on your capital and level of trading experience.
When trading Forex, it’s best to take on a defensive stance. Don’t rely on the probability of winning when deciding on leverage to use because your trade can move against you.
