When I started forex trading, I had a get-rich-quick mindset. For every trade I took I’d set an unreasonable leverage level. I wanted to make $5,000 with a $100 account on a single trade. I said to myself “‘If I can think it, I can do it”. But I never got rich. In fact, I ended up blowing my account 4 times due to overleveraging, and trust me it was not a nice feeling.
So if you are wondering why your Forex account is constantly getting blown, you probably have the same mindset that I did. You are overleveraging, and in this article, I will share with you how I was able to understand leveraging and used it to my advantage.
What is Leverage?
In forex trading, leverage allows you to control larger position sizes with small capital.
It is probably the best thing to have happened to forex traders, but it could also be the worst if not used properly.
With a capital of $200 and a leverage of 1:100, you can control a position size of up to $20,000. Sounds great right?
But think, if you can make profits trading as much as $20,000 with a leverage of 100:1 on a $200 account size, all it takes is a 1% drawdown and (Poof) your $200 is gone! Crazy right?
Leverage does not guarantee profits or success in trading. At this point, I need to emphasize that while leverage can amplify your potential gains, it can also amplify your potential losses.
What is overleveraging?
Overleveraging is the undoing of many traders. The fact that many traders don’t understand this, is something worth considering. Overleveraging occurs when you expose yourself to a larger risk of financial loss by taking on excessive amounts of debt relative to the size of your accounts. In forex trading, It occurs when you use a high leverage ratio, take on several highly leveraged positions, or trade with a disproportionately big position size in comparison to your available capital.
Why do people overleverage?
You might still be asking why some traders overleverage after knowing how bad it is? Well, here are a few reasons why some traders could be overleveraging:
Greed: The desire to make large and quick profits may drive you to overleverage your positions. You could be motivated to increase your exposure through leverage in order to increase your prospective profits, even if doing so involves taking on too much risk.
Lack of knowledge: You may be a new trader who does not fully understand the effects and risks related to leverage. You may underestimate the possible losses that could arise if trades go against you, which would lead to excessive reliance on leverage without adequate risk management.
Unrealistic expectations: You may have entered the forex market with unrealistic expectations of the potential profits you could make. In an effort to increase your profits and quickly reach your intended financial goals, you could overleverage. This may be caused by the Fear of missing out (FOMO) on potential profits.
Lack of discipline: Impulsive decisions and overleveraging may be caused by emotional factors such as fear, impatience, or the drive to recover losses. In pursuit of short-term gains or in an effort to quickly cover up losses, you could deviate from your carefully thought-out trading strategy and risk management procedures.
Overconfidence: Having excessive faith in one's trading skills can cause you to take on too much risk. You might ignore the underlying volatility and uncertainty in the financial markets because you think they can constantly predict market changes.
Influence of social media pressure: You may be influenced by the success stories and actions of others, particularly in online trading forums or social media. When you see others using excessive amounts of leverage and appearing to profit from it, you may get the fear of missing out and use more leverage.
How do you avoid overleveraging?
Certainly, there are ways to avoid overleveraging in forex trading. This requires strict risk management, emotional discipline, and appropriate decision-making. Here are simple ways to avoid overleveraging:
Photo by Hannah Jacobson on Unsplash
Trading on a whim is like “throwing caution to the wind”. In trading, you must maintain discipline and stick to your predetermined risk management rules. You must resist the urge to impulsively enter a trade or deviate from your trading plan.
Set realistic goals and expectations for your trading. Avoid the need to pursue extremely high returns in a short period. Instead, concentrate on long-term success and consistent growth.
Trade smaller position sizes, determine your position sizing based on the size of your account and your risk tolerance. Avoid trading large positions in relation to your capital, to reduce the danger of overexposure and potential losses.
Determine the maximum leverage level you are comfortable with. If you are not willing to lose your capital on one trade, then start with low leverage levels, compound your gains, and gradually increase your leverage.
Develop a trading strategy that takes into account your financial objectives, risk tolerance, and trading lifestyle. This strategy must define the highest level of leverage you feel comfortable using, as well as the kinds of trades that fit your risk tolerance.
Avoid revenge trading! Resist the urge to recover losses, because at this point you are driven by strong emotions such as anger, and frustration, and it could lead you to overleverage and make impulsive decisions.
Use Leverage sparingly: Excessive leverage might result in overexposure and substantial losses. Start with a modest leverage level, and as you develop expertise and confidence in your ability to trade, you can progressively increase your leverage level. Compound your little profits and with time you’ll notice a positive portfolio return.
Keep your emotions in check because they might cause irrational and impulsive decisions, such as overleveraging. When you keep your emotions under control, it allows you to refrain from chasing high-risk trades. Follow your risk management guidelines and trading plan strictly.
How to use leverage responsibly
These are ways to use leverage to our advantage and improve the quality of our trades:
Diversification: With leverage, you can spread your capital across various markets or assets. This helps you spread your risk and minimizes the potential effect of one trade on your portfolio.
Conduct thorough market analysis: Find high-probability trading opportunities using both technical and fundamental analysis. Use reasonable leverage in trades with favorable risk-reward ratios.
Monitor your trades: (Not saying you should interfere with your running trades But…) Stay updated on the market condition and monitor your leveraged trades. Be ready to exit positions if market conditions change or if your initial thesis is proven to be false.
Keep up with market news and events that could affect your leveraged trades and be flexible. Be adaptable and ready to change your trading plan and leverage levels in response to changing market conditions.
Photo by Austin Distel on Unsplash
When using leverage, it's important to apply caution, maintain discipline, and take smart risk management measures. Leverage can increase your profit, but it can also increase your losses. By following these guidelines provided you can leverage wisely and take advantage of its benefits.
Overall, the thought of using extreme leverage to make quick profit on a trade sounds great, but always consider the risk involved. Remember, by avoiding overleveraging, you increase your chances of long-term profitability and protect your trading capital.
Stop overleveraging and start setting realistic leverage levels!
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