How Forex Traders Use Leverage for Profit

Kathy Lien - Weiss Educational Reources Contributor

During your lifetime, you may have heard that only 5% of all Forex traders actually make money. Well this statistic is not only wrong, but it’s also completely misleading.

In reality, 20 to 30% of all Forex traders are profitable, which is better than 5%; but still, not high enough for most people to try their hand at Forex trading.

But let me share a little secret with you – in Hong Kong, approximately 50% or half of all Forex traders are profitable and there’s a way that you can boost those odds to 61%.

Their success has nothing to do with Tiger Moms but rather one very simple reason – leverage.

Do not be mistaken, the Chinese love get rich quick schemes. There’s a reason why Macau is the world’s gambling capital!  So they were quick to appreciate the attractiveness of leverage.

However, the Securities & Futures Commission of Hong Kong were smart – very early on leverage was limited to 20:1 and required an initial margin of 5%. During this time, leverage in the U.S. was as high as 100:1 and to this day you can find brokers outside of the U.S. offering leverage as high as 400:1.

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In 2010, U.S. regulators finally woke up to the danger of leverage and reduced it to 50:1 (2% margin) for major currencies, and 20:1 on minor currencies.

Leverage is a double-edged sword.  In reality, currencies do not move as much as equities. On a given day, a 2% move in the Euro / U.S. dollar pair would be significant whereas stocks can easily swing 5 to 10% a day. The ability to control a significant amount of money for only a fraction of investment is extremely attractive and when the moves are in our favor 50 times lever is great but when it moves against us, leverage can compound the losses and in some cases wipe out accounts.

Since 2010, the Forex market has changed but the stigma remained because after the 2008 financial crisis, there was less appetite and discretionary funds for alternative investments.

During this time, the Forex market remained a favorite of hedge funds, institutional investors and central banks and continued to grow.  Now, more than 5 trillion dollars’ exchange hands every single day in the Forex market, making it single-handedly the largest market in the world.

Thankfully how much margin we post and how much leverage we choose to use is a choice.  I always recommend no more than 5 times lever …and that’s only on your most confident positions.

One of the largest Forex brokers in the world recently conducted a study of 13 million trades and they confirmed that leverage has a negative relationship with profitability.

According to their study “Traders were considerably more likely to turn a profit on a given trade than a loss except when using over 25:1 leverage. Trades with leverage below 5:1 were profitable 61 percent of the time. On the opposite end, those with effective leverage above 25:1 were only profitable on 48 percent of all trades—a significant difference.”

So as you can see there’s no real secret to the success of Hong Kong Forex traders. Except to use lower leverage and you’ll automatically gain an edge.

Until next time,

Kathy Lien

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