By Adinah Brown
Leverage will turbocharge your trading profits in a way that nothing else can. It gives you the power to trade $50 dollars like it was $50,000, and lets you keep the profits on the $50,000 transaction. It’s the only way to trade in Forex, unless your last name is Zuckerberg.
But to some, leverage is considered toxic. Why? Because it can turbocharge your losses in the same way that it can turbocharge your profits. That makes it both very powerful and very dangerous.
So, which is it, toxic or turbo?
Both.
Leverage needs to be carefully used to create power for your trading.
There is only one fundamental way that you can make leverage work in your favor, and that is to pick the direction of the market. If your position is moving in the right direction, no amount of leverage in the world is enough.
But, even if the position is not moving in the correct direction, there are still a few tricks you can use to protect yourself.
Hedging
For anyone that does not know, hedging is when you open a position in the opposite direction to the position that you currently have. The net profit and loss from this situation is zero, so you are paying swaps for nothing, but it can have useful strategic value in that it can control the loss of a position if you are looking for the trade to turn around.
A useful practical method is a partial hedge, where the hedge position is not as large as the original position taken. It will effectively slow the losses without providing full protection. If you put in stops when the original position moves back into profit, you will have taken a portion of the profits off the table, but you will not be cutting into your ongoing profits.
Another option is to set a full hedge at the stop loss point of the original position. That way the original position remains open, but any movement below the stop loss point will trigger the hedge and cause you to effectively make no further losses. Again, when the original position moves into profit, you need to have a stop to remove the hedge.
Options
Businesses with foreign currency risk will often take out an options contract in order to stabilize the values of their income in different countries. Using an option as a hedge is a good way to ensure that your position has protection. It has more upside than a normal hedge, because you are not obliged to exercise the option, giving you control over the final cost of the hedge position.
So, even though leverage is the friend of traders in its ability to turbocharge profits, it can and will do the same with your losses. Using the methods described above, you can create a situation where the leverage is greater in the profit direction and less in the loss direction. To put it in simple terms, you can still turbocharge your profits without doing the same to your losses.
About the Author:
Adinah Brown is a professional writer who has worked in a wide range of industry settings, including corporate industry, government and non-government organizations. Within many of these positions, Adinah has provided skilled marketing and advertising services and is currently the Content Manager at Leverate.
