Financial leverage attracts a lot of traders to the Forex market. However, it is not the foolproof tool that some people make it out to be. While leverage can be beneficial, it can also lead to disastrous outcomes.
This is especially likely in the case of traders with no experience. It's also worth knowing that many large financial companies are actually practicing currency trading without leverage.
What are the advantages of trading with and without leverage? You can find out for yourself with a free demo account.
(You can also continue reading if you're not up for the challenge.)
Perhaps you already know what leverage is? If not, here's a brief rundown.
Financial leverage is a credit provided by a broker. Leverage allows traders to place orders that are significantly higher than their actual deposit. It is possible to use leverage to trade stocks and other financial instruments, but it is far more accessible when trading currencies.
Leverage potentially helps to achieve higher profits in the market. Of course, the same applies to losses. Traders risk losing their deposit faster when using leverage – so use it cautiously.
A trader has a deposit of 10,000 EUR. A trader's broker offers a leverage of 1:100 for a deposit of this size. Knowing these two values, we can easily calculate the largest position available to this trader.
We need to multiply the trader's balance by the first value in the leverage ratio, i.e. 10,000 multiplied by 100. So, this trader can open a deal up to 1,000,000 EUR in volume.
Of course, this may sound too optimistic.
Position size doesn't mean much if you are not aware of how you're trading. Before you begin trading, you should learn about the good and bad of trading, and then try it out without leverage.
The biggest advantage of leverage is that it allows traders to boost their trade sizes, even when they don't have substantial capital. Traders usually consider 1,000 USD to be a decent starting sum.
However, not all traders can afford this – especially when starting out. And this is where financial leverage comes into play.
Even leverage as low as 1:10, allows traders with a 100 USD deposit to open a 0.01 lot position. But this is not a 100% beneficial condition as you also expose yourself to risk.
Consider an example of trading with no leverage.
Let's say you buy 1000 USD for 800 EUR and then the price of USD drops by 50%. You would only lose half your funds, i.e. 400 EUR. However, if you were using 100:1 leverage and the price changed by less than 1%. You would lose all your funds.
Always be aware of the risk leverages poses and try to prepare yourself for it. Preparation can be as simple as practising leveraged and unleveraged trades on a demo account. If you can't create good returns with low leverage, expect massive loses with over-leverage.
The main downside of trading Forex without leverage, is that it is simply not accessible for most traders.
Forex trading without leverage means that changes in the price of an asset directly influence the trader's bottom line. The average monthly return a trader can generate is 10%. But in reality, the return is around 3 to 5% a month.
However, this figure already includes marginal trading.
With no leverage Forex trading, you would probably only make 0.3 to 0.5% a month. It may be enough for some Forex traders – but not for most. The need for substantial trading capital, is the biggest drawback of trading without leverage. On the other hand, currency trading without leverage, gives you less risk exposure.
However, this doesn't mean there are no risks involved in trading without leverage.
Ok, let's simply use an example of no-leverage trading. Let's say you deposit 10,000 USD and make a monthly return of 5%. You only get 500 USD each month, and that's before any taxation.
You can probably make the same money doing a 9-to-5 job, without risking your own capital in the process
As we've already mentioned, a lot of institutions choose Forex trading without leverage. Yet these organisations are still able to achieve large profits.
How is this possible?
Large banks have access to billions in capital. They can afford to trade large amounts on attractive entry signals. Institutions also often trade long term, so unlike the average trader, these guys can have their position open for months or even years.
Since they don't use leverage, the swap expense tends to be quite low too. In fact, in many cases there is no swap at all. Institutions directly benefit or suffer from the difference in interest rates.
Many of the largest Forex market trades have been made by institutions without leverage. These deals have a speculative motivation and typically use extensive capital in the billions.
That is the question.
But unfortunately, there's no definitive answer to it – it depends on the situation. You have to consider your trading strategy, your financial targets, the capital at your disposal, and how much you are willing to lose.
Like any financial market, the Forex market is generally risky.
The higher your leverage is, the riskier your trading gets. So consider trading with as little leverage as possible, to get the profit you want. And conversely, keep in mind that the more leverage you use in Forex trading – the more profit you can potentially make.
In most cases, a beginner trader should consider using leverage from 1:5 to 1:100.
The following table illustrates the importance of trading with the right leverage. It shows 10 losing trades in a row when using low vs. high leverage.
Hopefully, we've answered some of your questions about Forex trading without leverage.
By now, you should understand why leverage is risky and that high leverage means higher risk, with the possibility of higher return and vice versa. So again, practising with leverage on a demo account is a smart first move.
It is important to ensure your trading strategy considers your deposit amount, how much you are willing to lose and the minimum you are willing to make - before you start leveraged trading.
Keep learning, keep educating yourself, and most importantly, keep trying out new things.