The term leverage in forex trading refers to the use of borrowed capital to increase the potential return on investment. In simple terms, it allows traders to control a larger amount of currency with a smaller amount of actual funds. Forex brokers offer different leverage ratios to their clients, and one of the most common ratios is 1:3 leverage.
What is 1:3 leverage?
1:3 leverage means that for every $1 of actual funds in a trader’s account, they can control up to $3 in currency. For example, if a trader has $1,000 in their account, they can control up to $3,000 in currency. This means that they can open larger positions and potentially earn more profits if the trade goes in their favor.
However, it’s important to note that leverage can also increase the potential losses. If the trade goes against the trader, the losses will be magnified by the leverage. For example, if the trader in the above example opens a position of $3,000 and the trade goes against them, they could potentially lose their entire account balance of $1,000.
Pros and cons of 1:3 leverage
Like any other financial instrument, 1:3 leverage has its pros and cons. Here are some of the benefits and drawbacks of using 1:3 leverage in forex trading.
Pros:
1. Increased buying power: With 1:3 leverage, traders can control a larger amount of currency with a smaller amount of actual funds. This means they can open larger positions and potentially earn more profits.
2. Flexibility: The use of leverage allows traders to be more flexible in their trading strategies. They can open positions in larger lot sizes or multiple positions simultaneously, which can increase their chances of success.
3. Lower capital requirement: Since leverage allows traders to control larger amounts of currency with a smaller amount of actual funds, it means they don’t need to invest a large amount of capital to start trading.
Cons:
1. Increased risk: Leverage magnifies the potential losses as well as the potential profits. If the trade goes against the trader, the losses will be magnified by the leverage, which could potentially wipe out their entire account balance.
2. Margin call risk: Since leverage allows traders to control larger amounts of currency, it also means they need to maintain a certain level of margin in their account. If the account balance falls below the required margin level, the trader will receive a margin call, which could result in the closure of their positions.
3. Limited trading opportunities: Some brokers may restrict the use of leverage for certain currency pairs or during certain market conditions. This can limit the trading opportunities for traders who rely on leverage to increase their buying power.
Conclusion
1:3 leverage is a popular leverage ratio offered by forex brokers. It allows traders to control a larger amount of currency with a smaller amount of actual funds, which can increase their potential profits. However, it’s important to remember that leverage can also increase the potential losses, and traders should always use it with caution. Before trading with leverage, traders should educate themselves about the risks and benefits and always use proper risk management techniques.
