Forex Leverage:Traders beware!!

Our previous discussion on selecting brokers would not be complete without touching on the most important thing they make available to you, the trader. And that thing is called LEVERAGE.

Leverage can be a magic word or a painful word depending on how you employ it. All brokers offer it and will often use it as an incentive to attract you: "GET STARTED TODAY! 400:1 LEVERAGE, MINIMUM STARTING BALANCE $250" Wait a minute...i thought it took money to make money?!?! Forex is unique in that it rivals all other markets out there when it comes to the amount of leverage made available to traders.

Picture this: A trader starts with a balance of $1000, places a trade that turns out to be a winner worth 100 pips (a pip, as you have probably already read in your studies, represents the minimum price fluctuation a currency pair can make.)Depending on the type of account this trader has, this 100 pips could represent $1000profit. How about that!! A profit of 100% on a single trade!! INCREDIBLE! It is leverage that makes this kind of return possible.

Is this an exaggeration? Not at all! And it is this potential that attracts so many new traders to this arena. It is possible. But it is also what sees most traders leave significantly poorer than when they came. Leverage is what makes this market most attractive but misusing it makes it most dangerous as well. And unfortunately way too many traders misuse it.

Let's get specific here. I'm not sure how up to speed on this concept you are, but this article provides a pretty complete picture of the idea:

(So you have a more involved understanding of the article, let me just point out that brokers typically offer 2 types of accounts, a standard and a mini account. The standard account allows you to control lots each worth $100,000 worth about $10 per pip, and minis allow you to control lots of $10,000 worth about $1 per pip.)

http://www.investopedia.com/articles/forex/07/forex_leverage.asp

Spend some time with this article and make sure you fully understand the dynamics of leverage. It may seem like there are alot of calculations to consider before initiating a trade to make sure you don't overleverage yourself, but in reality it doesn't have to be that involved. The above is meant to give you a detailed breakdown of things so you fully appreciate the concept. But when it comes time for you to trade, you just need to keep it simple.

Understanding how leverage will fit in to your overall money management plan is important but let's put things into perspective a little more simply by looking at how most professionals deal with it (and this is really what i want you to take home from all this):

Most professional traders and money managers trade in such a way that they are never risking more than 2% of their total trading capital on any single trade. In other words, if you have a $5000 account, you should never lose more than $100 on any single trade. This means you should probably be trading 1 or 2 mini lots per trade at the most. This will probably equate to about 4:1 REAL leverage (depending on stop-losses you use). This is the most leverage a beginner should use.

Do not let emotions like fear and greed influence you at this early stage of the game. Rest assured there are ways to overcome these basic human emotions in the trading arena that we will discuss in later posts, but for now just trust me. Use leverage conservatively and intelligently.

Place your trades with this perspective in mind and leverage will take care of itself. If the pros do it this way, don't think for a second that a newcomer can use loads of leverage and survive for long. Won't happen.