If you’ve ever traded forex then you probably know that all forex traders use leverage in their positions. Leveraging trades has become such common practice in the forex trading industry that today it’s hard to find completely unleveraged positions in the market. Since price rate movements in the forex market are usually very minute and almost unnoticeable, traders need to invest huge amounts of capital in every position in order to profit from the market movements. The problem is however, that most traders in the market, with the exception of immense financial institutions such as banks, don’t have the kind of capital it takes to make real money off their investments. The solution is leverage. Leverage is a kind of “loan” that the forex broker gives to its traders in order to enable them to capitalize on price rate movements. The great thing about leverage is that a trader can open positions for tens of thousands of currency units while investing only $50 or $100 of his or her own money.
But, as the poet said, every rose has its thorn. Just as a highly leveraged position can increase the trader’s profit, it also makes it very vulnerable to market fluctuations. Since every invested dollar in fact represents hundreds or thousands of dollars, every slight shift in the currency pair’s rate can demolish the position. Therefore it is extremely important for every forex trader to learn how to use leverage wisely to their advantage without exposing themselves to too much market risk.
The genera strategic idea behind selecting your leverage is that the surer you are of your trade the more you can leverage it. If you’re not exactly sure of your trade, or if you’re not sure of the stability of the currency pair’s trend, it’s always best to lower your leverage so as to minimize your vulnerability to unpredictable changes in the price rate.
Many traders will open a kind of trial position to test out the market before committing to a high leverage position. This means that they will open a small position with a low leverage to see how the position holds against the market movements. If they see that the position is indeed profitable as they thought, they’ll open a larger position with a higher leverage to capitalize on the profit opportunity. If on the other hand the market turns against their position they can close it without having suffered a great loss.
Leverage selection also depends on the time frame you plan to trade in. Very short term positions rely on the high volatility of the market and therefore do better with a high leverage, since this kind of leverage allows bigger profits in the short term. Long term positions on the other hands require more stability, especially since you can’t monitor the trade around the clock. It is then best to use a lower leverage, or even no leverage at all, when opening a position that you expect to yield profit over the course of several weeks or even months. A lower leverage allows the trader to make a serious long term investment in foreign currency that can withstand minor knee jerk market reactions.

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