Leverage is a mechanism that allows traders to control a larger position in the market with a smaller amount of capital. Basically, a broker lends additional funds so traders can increase the size of their trades.
Example:
Let's say a trader wants to open a 10-lot trade on EURUSD. With their own money and without leverage, this would require approximately $1.08 million.
But, when trading with leverage, like the FundedNext Stellar Account providing 1:100 leverage, the same 10-lot trade now requires only approximately $10.88k.
This is how FundedNext helps you with both funding and leverage to boost your trading capability.
Impact of Leverage on Trading Outcomes
By using leverage, traders can take larger trades with less money, and larger lots increase the potential to make more money out of the market. But this also increases the pressure to manage risk carefully, as larger positions can magnify losses.
Leverage unlocks the door for traders to take multiple positions. Without leverage, a trader would be unable to take multiple trades, missing potential profit opportunities.
Lower margin requirements from leverage help traders stay in trades longer and maintain multiple trades, allowing them to take advantage of various market setups.
Overleveraging in Trading
Overleveraging is when a trader opens positions that are too large compared to their account balance. For example, let’s take a trader using the 6K Stellar Account with a leverage of 1:100. They want to open a position of 5 lots in EURUSD, which requires $5,451.65 of their account balance as margin. This means this single trade will use up 90.86% of the trader's total available balance. In this scenario, the trader can face multiple do-or-die situations.
The trader can lose more money than expected due to overleveraging. Not only losing money but also if the account balance gets too low, the trader might face a margin or even stop out call forcing the trader to close the running trade(s).
All of this leads to emotional trading and long-term psychological damage. Large losses create panic, while big wins can lead to overconfidence. This often causes traders to make poor decisions, leading to even more losses.
To avoid this risk, successful traders typically risk no more than 1% at a time and use only 20% to 30% of their total margin. By using leverage responsibly, setting realistic risk limits, and maintaining a disciplined approach, traders can enhance profitability while minimizing unnecessary risks.
"Leverage is a two-edged sword. It's wonderful when the trade is going up, but you're out of business quickly when it goes the other way." - Craig Effron (Founding Partner, Scoggin Capital Management).