There is no doubt that forex trading can be risky. For one thing, any future outcome is not entirely predictable. Currencies change value in comparison to one another for reasons and to degrees that at times defy logic and comprehension. When real money is at stake in a forex transaction, the fact that currencies are traded on margin magnifies the rewards of being right and the penalties for being wrong. Many forex brokers, with the exception of those that comply with U.S. regulations where leverage is capped at 50:1, offer typical leverage levels around 100:1, 200:1, and in some cases as high as 500:1.
Here are some examples of the effect different levels of leverage produce that are based on the EUR/USD currency pair. The following numbers are just examples. Different brokers can and do vary in this regard. All the examples are based on a $1000 margin account for the purpose of keeping the math simple. The exchange rate used is a recent one, 1.3150. At 50:1 leverage and at recent exchange rates, $1000 of margin would permit a trader to buy or sell a maximum of 38,023 units. Ignoring any intermediate leverage levels and going to a 500:1 leverage, $1000 of margin can control 380,230 units. This example is for purposes of illustration only. No one should ever enter a transaction for the maximum number of units their margin supplies, unless they are approaching forex trading as gambling. At 50:1, each pip change in price of the EUR/USD at the maximum units would equal $3.8023. At 500:1, this figure increases ten times to $38.023.
The point here is to demonstrate how increased leverage makes more currency units available. Higher leverage equals greater risk if the trader is incorrect in the prediction of price direction. It does also equal greater reward if the trader is right. This is the proverbial two-edged sword represented by the concept of leverage. New traders are generally advised to start at lower levels of leverage until the actual experience of witnessing the effect on the P &L of the trading account can be mentally assimilated. All traders are generally counseled to never add units to a losing trade. This old adage of trading bears closer examination. If done properly, adding additional units to a negative forex trade will produce an average entry price that is closer to the current market price. This will often provide an opportunity to close a trade if prices reverse to the breakeven point.
It does require a considerable amount of personal discipline to exit a trade that looks to be on the verge of becoming profitable. Experienced traders who have used this price averaging technique can all recall many instances where they were wrong on a trade, added to it to improve their average entry, and then instead of closing the trade when they could get out for a small loss or small profit, held onto it only to see the market reverse against them again. Traders who want to try this tactic should make the initial entry a very small fraction of the total units available. In the above 50:1 scenario where there are 38,023 units available, the first entry should be no more than 1000 units, even slightly less if the forex broker being used will accept smaller orders.
