One of the biggest secrets and misunderstandings of what makes forex trading risky involves one of the features that also makes it so attractive as a trading vehicle.

And that big, big, secret can be summed up in only one word. Leverage.

When you measure the annual price range of any forex market you will find that the percentage from low to high or from high to low is about the same as you would expect from the stock market.

That is, for example, if the NYSE started out the year at 12,000 on the Dow and finished the year at 13,500 the percentage gain would be 12.5%.

Let’s say over the same time period the Euro went from 120.00 to 135.00. That would be a gain of, gasp, 12.5%.

That’s a nice gain but hardly the kind of stuff that gives the forex market its reputation as a highly volatile, risky speculation. So why the different in the perceived riskiness of the two markets?

Ahhhh. I’ve already told you the secret, it’s leverage.

In your stock trading account your stock brokerage firm will allow you to establish a margin trading account. The most leverage that they can give you by current law on say a $100,000 account is another $100,000. So you could trade $200,000 worth of stocks with $100,000 cash in your account. The additional leverage increases your risk but also increases your profit on winning trades.

Using the example of the gain in the Dow above if you had the same degree of gain in your account and you were fully margined you would have a 25% gain instead of a 12.5% gain.

However, in your forex trading account an online brokerage firm may give you 100×1 leverage or even more. Wow! Now with your $100,000 you can trade 100 times that amount in currency or $10,000,000. Welcome to the big leagues. Better enjoy it while you can as if you take them up on their offer you probably won’t survive for long.

Why is that, you may ask? Well at 100 to one leverage a one percent move in your favor will double your money. That not a lot of movement as daily fluctuations often exceed one percent. At 135.00 for the Euro a one percent move would be 1.35 pips.

Of course, it’s wonderful if you were on the right side of the trade. Your $100,000 just became $200,000. Very nicely done.

However, and a big however at that, if you are on the wrong side of the trade a one percent move against your highly leveraged position will reduce your $100,000 to zero. Your account has just been totally wiped out.

Bummer. Maybe trading at 100 to one leverage wasn’t such a good idea after all.

You should always keep in mind that the leverage employed on any trade in your account is totally under your control. Just because some ridiculous amount of leverage is offered doesn’t mean that you have to use it.

This is where discipline and trading according to a plan comes into play. And not getting too greedy and too sure of yourself.

If you want to take on risk and go for broke the forex markets will gladly accommodate you. However, if you want to trade at low risk you can do that too.

To trade forex at the lowest risk trade without any leverage. That is with your $100,000 buy or sell $100,000 dollars worth of Euros. At 135.00 that would be about 74,074 Euros.

If you want more risk and a higher potential for profit increase the ratio. Let’s say you use five to one leverage. Now you can trade $500,000 worth of Euros. So at a price of 135.00 you buy 370,370 in Euros. Now a one percent move in your favor will earn you 1% of 370,370 or 3,703.70 Euros. Based upon the 74,074 Euros you started with you are 5% ahead on the trade.

Is this a big secret that I’m revealing to you? You bet. Using too much leverage in accounts is the number one reason that traders lose money in forex. By over leveraging, even when using close reasonable stops, too much capital is put at risk on each trade. A small series of losing trades can seriously deplete a traders capital, even completely knock him out of he game.

My advice. By all means use leverage in trading forex. That’s the fire power that makes forex so interesting. However, use a reasonable amount of leverage. Anything over ten to one is very risky indeed. Many professional traders and fund managers are happy to stay within a five to one ratio.

Since you as the account owner to a large degree control the amount of leverage that you use make sure you that fully understand how the amount of leverage used on each trade will impact your trading results.

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