In our last lesson we learned how to calculate profits in the forex market so we can determine our potential risk and reward in US Dollars before entering a trade. In today's lesson we are going to continue our forex trading course with a look at something which is known as leverage.
While the forex market has a reputation for being a very risky and volatile market, when talking about the main currency pairs of the world it is actually one of the least volatile markets there is. While a 2% move in a day is fairly common in many stocks and futures contracts, this would be considered a pretty large move in most of the main currency pairs and their crosses.
So if this is true then it begs the question of why the forex market has such reputation for being a very volatile and risky market to trade. The answer to this question has to do with something which is known as leverage and the fact that in the forex market traders are given access to a much higher amount of leverage than in most other markets.
When we talk about leverage in the financial markets we are talking about the ability to amplify the gain or loss on a trade through the use of either borrowed capital, or a financial instrument which is structured to accomplish this.
To point to an example that many people are familiar with lets look at what happens when most people go to buy a house. As most people do not have all the cash they need on hand to simply pay for the house out of pocket, they go to the bank and get a mortgage so that they can afford to buy the house. To obtain this loan the buyer of the home will generally put down some capital upfront, a common number for which is 20% of the purchase price.
So lets say for example that I go and take out a mortgage for a $1 Million house and put up 20% ($200,000) in order to obtain a mortgage from the bank for the balance of $800,000.
Next lets say that over the next year the value of my house goes up by 5% of the purchase price, so that the house which was worth $1 Million is now worth $1,050,000. While the value of my house in this example has gone up by 5% the return on the money that I invested in the house ($200,000) is actually much higher than this.
The reason for this is something which is known as leverage. As we can see from this example leverage allowed me to buy an asset (in this case a house) with only 1/5th the money that I would have needed had I put up all the money myself.
So in this example the return on my investment is not 5% but the increase in the value of the property ($50,000) divided by my down payment ($200,000). This equals a return of 5 times the 5% gain on the value of the property or 25%.
When people first see the power of leverage they normally get very excited, as the gambler seeking the slot machine jackpot that is in all of us starts to take over the brain. What it is important to realize however is that just as in this example a 5% gain in the value of the house resulted in a 25% gain on the original investment, if the value of the house falls by 5% in this example this would represent a loss of 25% on the original investment.
As we continue our discussion on leverage it will become clearer that one of the main reasons the forex market has a bad name, and why so many traders blow themselves up early on in the market, is because they over leverage themselves. While this may work to amplify their gains initially, eventually a loosing streak which always eventually comes does come along and knocks them out of the game completely.
For your homework assignment tonight I encourage you to place a few more trades on your demo trading accounts and notice how the different columns in the accounts window of the platform react when you do this. If you have not done so already you can register for a free real time demo account in the link above this video if you are watching on InformedTrades or to the right of this video if you are watching on YouTube.
Thats our lesson for today. In our next lesson we will look at the logistics of trading on margin on our real time demo trading accounts so we hope to see you in that lesson.
Elevate Your Trading With The Amazing Trader!
The Amazing Trader includes:
Actionable trading levels delivered to YOUR charts in real-time.
POTENTIAL PRICE RISK: HIGH to Medium- Wed --14:15 GMT-- US- Industrial Production
POTENTIAL PRICE RISK: HIGH- Wed -- 15:00 GMT-- CA- Bank Of Canada Decision
John M. Bland, MBA co-founding Partner, Global-View.com
Max McKegg's Daily Forex Trading Forecasts
Veteran FX Trader, Max McKegg, forecasts all the Major currencies and the Australasians; providing Daily and Medium Term Trading forecasts to subscribers, who include large Banks the world over, as well as individual traders in more than 30 different countries.
looking for your first broker or do you need of a new one? There are
more critical things to consider than you might have thought.
We were trading long before there were online brokers. Global-View
has been directly involved with the industry since its infancy. We've
seen everything and are up-to-data with recent regulatory changes.
The Global-View Forex Forum is the hub for currency trading on the web. Founded in 1996, it was the original forex forum and is still the place where forex traders around the globe come 24/7 looking for currency trading ideas, breaking forex news, fx trading rumors, fx flows and more. This is where you can find a full suite of forex trading tools, including a complete fx database, forex chart points, live currency rates, and live fx charts. In addition, there is a forex brokers directory where you can compare forex brokers. There is also a forex brokers hotline where you can ask for help choosing a forex broker that meets your individual fx trading needs. Interact on the same venue to discuss forex trading.
The forex forum is where traders come to discuss the forex market. It is one of the few places where forex traders of all levels of experience, from novice to professionals, interact on the same venue to discuss forex trading. There is also the GVI Forex, which is a private subscription service where professional and experienced currency traders meet in a private forex forum. it is like a virtual forex trading room. This is open to forex traders of all levels of experience to view but only experienced currency tradingprofessionals can post.
Currency trading charts are updated daily using the forex trading ranges posted in the Global-View forex database. You will also find technical indicators on the fx trading charts, e.g. moving averages for currencies such as the EURUSD. This is another forex trading tool provided by Global-View.com.
The forex database can be used to access high, low, close daily forex ranges for key currency pairs, such as the EURUSD, USDJPY, USDCHF, GBPUSD, USDCAD, AUD, NZD and major crosses, including EURJPY, EURGBP, EURCHF, GBPJPY, GBPCHF and CHFJPY. Data for these currency trading pairs dating back to January 1, 1999 can be downloaded to an Excel spreadsheet.
Forex chart points are in a currency trading table that includes; latest fx tradinghigh-low-close range, Bollinger Bands, Fibonacci retracement levels, daily forex pivot points support and resistance levels, average daily forex range, MACD for the different currency trading pairs. You can look on the forex forum for updates when one of the fx trading tools is updated.
Global-View also offers a full fx trading chart gallery that includes fx pairs, such as the EURUSD, commodities, stocks and bonds. In a fx trading world where markets are integrated, the chart gallery is a valuable trading tool. Look for updates on the Forex Forum when the chart gallery is updated.
Global-View.com also offers a forex blog, where articles of interest for currency trading are posted throughout the day. The forex blog articles come from outside sources, including forex brokers research as well as from the professionals at Global-View.com. This forex blog includes the Daily Forex View, Market Chatter and technical forex blog updates. In additional to its real time forex forum, there are also Member Forums available for more in depth forex trading discussions.
WARNING: FOREIGN EXCHANGE TRADING AND INVESTMENT IN DERIVATIVES
CAN BE VERY SPECULATIVE AND MAY RESULT IN LOSSES AS WELL AS PROFITS. FOREIGN
EXCHANGE AND DERIVATIVES TRADING IS NOT SUITABLE FOR MANY MEMBERS OF THE
PUBLIC AND ONLY RISK CAPITAL SHOULD BE APPLIED. THE WEBSITE DOES NOT TAKE
INTO ACCOUNT SPECIAL INVESTMENT GOALS, THE FINANCIAL SITUATION OR SPECIFIC
REQUIREMENTS OF INDIVIDUAL USERS. YOU SHOULD CAREFULLY CONSIDER YOUR FINANCIAL
SITUATION AND CONSULT YOUR FINANCIAL ADVISORS AS TO THE SUITABILITY TO YOUR
SITUATION PRIOR TO MAKING ANY INVESTMENT OR ENTERING INTO ANY TRANSACTIONS.