IronFX, What is Forex Leverage?
What is leverage in the Forex market? How does it work?
- What is Leverage in Forex?
- Forex Leverage Can Boost Your Profits?
- Example of Forex trading with Leverage
What is Leverage in Forex?
Leverage is the strategy of using borrowed money to increase return on an investment, something which is widely used by small investors.
The idea is simple: count your broker as a bank, which fronts you money to trade with, asking for a good faith deposit in return.
This means that you will be allowed to trade more significant positions by borrowing money from your broker, while the broker would set aside the required amount of your deposit (called “margin”) and let you “borrow” the rest.
The minimum margin for each lot depends on your broker’s requirements.
You get it back when you close your trade; however, the broker requires this deposit to cover the risk in which you may lose money on your position.
Any losses or gains will be deducted or added to the remaining cash balance in your account, while you would have to keep enough funds on your account’s equity to be allowed to keep your trades open according to margin requirements.
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Forex Leverage Can Boost Your Profits?
Your leverage can differ depending on the Forex broker you choose.
However, this doesn’t have any significant impact on your possible profits. The main benefit of your trading shoulder is that you may place more trades.
Your income is still equivalent to the percentage of your trade result added or taken off from your actual invested amount.
Leverage is the sum of borrowed capital used to increase liquidity and potential for return opportunities.
Trading on leveraged capital means that you can trade in amounts significantly higher than the balance of your funds, which means your balance only serves as the margin.
Heightened leverage can significantly increase your potential returns, but it can also increase chances of risk and loss.
Leverage is presented as a ratio, such as 200:1. This means that you can trade amounts 200 times higher than the sum of funds available in your account.
For example: if you have $1,000 in your account, it means that you can now open trades worth $200,000.
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Example of Forex trading with Leverage
Borrowing money from a broker to purchase stocks is called buying on margin.
Normally you can borrow up to 50% of the purchase price of a stock.
For example, with the deposit of $5,000 in margin account you have $10,000 worth of buying power.
This means that if you buy $2,000 stock, you still have $8,000 in buying power remaining.
Until your cash can cover a transaction, you are not using your margin.
You will start using it only when you buy over $5,000.
Simply put, leverage allows traders to trade on a large investment size, without having to put up the full amount.
This means that a small account balance can control a much larger total contract value.
For example where leverage is 1:100, it means that for every $1 invested in the market, the broker invests $100 for you. So, with a deposit of just $100, the trader can access $10,000.
Leverage makes a trader with a small investment size have the same potential as a trader with a much bigger investment size.
The maximum leverage offered by brokers are different from 1:5 to 1:5000.
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