subject: Leverage In Foreign Exchange Explained And Exposed [print this page] Lots of people new to trading get confused by the concept of leverage in Forex, how it is calculated and how it should be used. If you are just starting out trading, you should approach leverage with caution because this very powerful tool can also work against you.
The Basic Concept:
If you open up a standard Forex account with most brokers, you will find they deal in lot sizes of $100,000. To make a single trade with your account, you are going to need $100,000 to place on it. There are not many of us that could afford this, and so leverage is offered by brokers to traders.
To allow people to trade these large lot sizes, brokers will effectively loan you money to place the trade provided you give them a percentage of the trade as a security against it. Should your trade move against you by more than what you gave the broker as security then you are out of the game and your money lost, should it move your way then you should make a good profit.
More Details On Leverage In Forex:
The standard format for expressing how much leverage a broker offers is as follows - 100:1. In this example, it means that for every $100 traded you need to provide $1 security (1%). Similarly, 200:1 means they are offering trades with only 0.5% security (1 / 200 * 100(%)) and so on. You may see brokers go as high as 400:1 (0.25%).
You may also see the word 'margin' used when leverage in Forex is talked about. The margin is always expressed as a percentage, and it is the figure that represents the percentage of the trade required as security. In the case of 100:1 leverage, the margin is 1%.Forex margin trading and leverage trading are generally used interchangeably to refer to the same thing.
Leverage In Use:
You can see now that by using leverage in forex trading, you can typically control a trade of $100,000 by only risking $1000 yourself, because the broker loaned you the other $99,000. Bear in mind thought, that as previously stated, if your trade were to fall by $1000 your trade will close. Once your $1000 is wiped out, the broker isnt going to risk his money on your trade if it continues to fall.
If you trade with a margin of just 1%, the trade needs only to drop by this small amount to get wiped out. The Forex market is a highly volatile one, and movements of 1% are common. Your trade may have turned around and made a profit after it dipped, but your trade was already gone. Because in this example the 1% margin gave you no room to let the market fluctuate a little, you lost out on potential profit. When this happens, it is called being too heavily leveraged.
Avoiding Small Margins And Heavy Leveraging:
Follow this link to learn more aboutforex trading strategies that don't put you at risk of being too heavily leveraged, which is vital in protecting your trading account.
Many tradersare using leverage as a way of controlling large lot sizes without the full investment, because they have learned to use it responsibly and to their benefit.
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Leverage In Foreign Exchange Explained And Exposed
