August 7, 2020

What Is Leverage in Forex Trading?

What is leverage in Forex trading? What will be the benefits of leverage? Forex marketplaces possess lots of benefits, such as non-spreads, diverse assortment of tradable tools, 24/5 usage of capital marketplaces. But when you want my opinion, certainly one of the primary features of Forex is leverage. So far as I could observe lots of Forex traders (new or experienced ) continue to be confused concerning the performance of leverage. Therefore, I hope this guide will allow you to find most of the answers on your own head.

The leverage in forex marketplaces enables one to open an increased amount of trades using a relatively low quantity of capital. However, as I wrote previously, chief component which may influence your benefits and losses would be your lot dimensions. But in the event that you’re a new trader, I won’t recommend you to use very high leverage before you gain some experience. Because like I said, with higher leverage you can execute larger trades.

Basically, you can boost your account with the help of leverage. Leverage ratio is changed from broker to broker. You can find brokers that offer you leverage ratios from 1:100 to 1:1000. For assets, commodities, cryptocurrencies and futures, leverage is lower than other instruments. This ratio changes depending on which broker you are working with and maximum leverage offered by brokers varies based on the regulation.

Leverage Example

Let’s say your broker offers maximum leverage of 1:100. You normally need $100.000 to open a 1 lot trade, but you can open that trade with only $1.000 margin thanks to the leverage ($100.000/100=$1.000). This means with $1.000 deposit, you can invest as a lot of as $100.000 with the help of leverage.

If you are using 1:200 leverage, then you will need just $500 for that ($100.000 / 200 = $500). As you can see as the leverage ratio goes higher, the amount of capital you need for your trades goes lower.

You want to sell EURUSD and assume that the EURUSD exchange rate is 1.20. When you execute 1 lot of EURUSD orders you normally need $120.000 margin (100.000 x 1.20 = $120.000). With the help of 1:100 leverage, you will need a $1.200 margin to execute that trade.

When used correctly, high leverage is a big convenience but that requires successful and disciplined risk management. Otherwise you can lose all of your investment very quickly because of the high leverage.

I will give you an example. Let’s say you bought 1.0 standard lot (100.000 units) of EURUSD at the cost of 1.20 which is worth to $120.000. You have $2500 in your trading account and the forex broker locked $1200 margin for that trade if your account uses 1:100 leverage.

If the cost of EURUSD goes down by only 250 pips to 1.1750, you would lose all of your capital because you invested 100.000 units. Do the simple math and 100.000 unit of EURUSD at the cost of 1.1750 equals to $117.500.

Therefore, leverage is both your enemy and friend depending on how you understand and use it appropriately. Also, forex Brokers that offer you high leverage is tricky. Many unregulated forex brokers will try to attract traders with very high leverage, so I advise you to be careful about that. Make sure that the forex broker you choose is regulated and reliable.