Key Trading Component / Concept - Leverage

We trade Forex using leverage. Using of leverage allows us to have exceptional gains when the market moves in our favor. On the other hand, if it moves against us, it will crash us badly. Because of leveraging, we must have stop loss so that we will not be wiped out by just one wrong trade. Not only that, it may end us up in trouble. Fortunately, almost all brokers have internal control where they will close out your position when you fund dries up. This is important in 2 sense. One, it protect the broker itself from unnecessary credit problem. Two, it protects the customer from over committing. This is win-win situation.

The concept of LEVERAGE is very important in trading particularly in Forex. The reason that a good trade can make lots of money fast because of leveraging. Without which, it would not have been possible unless someone has huge capital. The use of leveraging also means the proportional increase of risk.

When you are trading using leverage, you cannot take long term position. The simple reason is that even though you are CORRECT in your LONG TERM view of the market, you may be STOPPED OUT of your position when you are using LEVERAGE. The fluctuations in the market will be amplified by your leverage and you may end up with margin call even though you know that in the long run, the market will move towards your favor.

Because of leveraging, FOREX traders will take short term position up to a few days only. Because of that, it also caused the fluctuations to be rather high. That itself provides ample opportunity for short term traders like day-traders to make very profitable trades (or make huge losses).

In essence, at the end of the day, Profit = Reward - (Risk + Transaction Cost). In order to make a profit, the Reward must exceed Risk by bigger amount. Assuming Transaction Cost is 1% then:

Reward / Risk > 0.51

in order to be profitable.