What Is Leverage In Forex?

By Steven Hatzakis Saturday, January 13, 2018

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Leverage in Forex is a double-edged sword but used a lot in trading, making it a basic yet essential term that every trader has to understand fully.

Introduction

There are now more and more traders participating in the Forex market and if you’re new to this, you would often hear the term leverage while trying to gain higher profits. Leverage in Forex is what makes the mundane market more fun and exciting. It brings out the gambling element in the market by putting a lot of your money on the line.

What Is Leverage?

Leverage enables traders with a small amount of trading funds to manage large positions. For example, with 50:1 leverage, a position worth $50 can be controlled by just $1 in a trading account. This can be a double-edged sword because both your profits and losses become more significant based on the leverage used.
The compulsory amount that needs to be deposited into an account will depend on the margin decided by both the trader and broker. 100,000 units of currency are for standard trading. The margin required for this level of trading is normally from 1 – 2 percent. In order to trade a position with $100,00 on a 1 percent margin requirement, traders would need to deposit $1,000, which means the investor will trade 100 times more than the original margin. In this situation, the trader is using a leverage of 1:100, meaning that a unit controls 100 units.

It is important to be aware that in leveraged trading, margin privileges are extended for traders to make currency trading more fluent and efficient. To avoid any unexpected changes in the trade, it is crucial that traders meet the minimum margin requirements in every open position.

Why Is Leverage In Forex Important?

The clear advantage of using leverage is that you can earn a significant amount of money with only some amount of capital. Albeit, you have to use leverage wisely and conservatively with risk management skills in order to prevent any critical losses.
To elaborate, let’s have a look at the EUR/USD (Euro against US dollar) trading pair. Without leverage, the trader would have to use the maximum value of the position in the Forex trading account to buy or sell a 100,000 of EUR/USD, which means an amount $100,000. However, with only $2,000, the trader can also open and keep the $100,000 EUR/USD position by using a leverage of 50:1 (2% margin required).

It’s normal to see a 10% move in your account in one day if you’re not careful while using high leverage.  It is also important to get a grasp of the volatility since the amount of leverage tends to be high.

Leverage Amounts

The amount of leverage typically depends on different brokers based on their rules and regulations. It can be 50:1, 100:1, 200:1, or even up to 400:1.

50:1 leverage (fifty to one leverage) means for each dollar you have in your Forex account, you can trade on the market with $50.

For example, you can trade with an amount of $50,000 on the market when you have deposited $1,000 using leverage. This doesn’t mean that you should trade the full $50,000, but it enables you to trade up to that amount.
  • *   100:1 leverage (one hundred to one) means that for each dollar you have in your Forex account, you can trade on the market with $100. This is the commonly used leverage amount on standard lots. A minimum of $2,000 in a standard lot account would enable you to open a trade amount of $200,000.
  • *   200:1 leverage (two hundred to one) means that for each dollar you have in your Forex account, you can trade on the market with $200. This is the commonly used leverage amount on mini lots. With $200 deposited, for example, you can control a maximum amount of $40,000
  • *   400:1 Leverage (four hundred to one) means that for every dollar you own in your Forex account, you can trade on the market with $400. You should be cautious of any broker who offers this kind of leverage for small accounts. With just a few hundred dollars deposited in the account, anyone who tries to trade with 400:1 leverage could be immediately annihilated in just a few minutes without precaution. Those brokers may also have ulterior motives so they won’t be acting with your interest in mind.

Note When Using Leverage In Forex

Leverage is a double-edged sword!
Most professional traders trade with very low leverage such as 10:1 or 20:1 in order to protect the trades when things go out of hand and keep earnings more consistent. This also means that you’ll have to put in more money and trade less.
Without much said, you need to always keep in mind that it’s dangerous to exploit leverage too much even if you are allowed to. It really requires knowledge and experience in order to figure out the correct timing of leverage. Moreover, it is advised that you stay vigilant in the Forex market to react quickly when something goes wrong. In best cases, while trading with small market fluctuations, a trader can use the highest amount of leverage possible to ensure the most profitable trade.

Conclusion

Some may argue that the job of a trader compounded is simply to manage all of the market’s parameters and deduce the best results that would bring back profits, but to master this job, it takes you a long time of study and practice. And leverage is one thing that every Forex trader has to understand fully.

Hopefully, this post gives you enough information about leverage in Forex. If you have any questions, leave it below. Thank you for reading!