What is Leverage in Forex?

What is Leverage in Forex?

 

Leverage in ForexLeverage in Forex! People travel all over the world and exchange different currencies. It enables them to have the currency of the country that they have traveled to. Others have exchanged money for different currencies to use them in trading. If you have done all this, this is forex. Forex is known to be the acronym for foreign exchange and is mostly known as currency trading. Some people borrow capital to invest it well and make greater profits, this is known as leverage. There are advantages and disadvantages of borrowing money to invest.

One of the advantages is that you can make a considerable amount using a limited amount of capital. Also, you can trade with the borrowed money; hence you have a margin to be able to open more positions to make more money. Leverage also boosts your money capacity and gives good results since most of the time; leverage is offered instantly and modified to what you decide. But with all these advantages there are some disadvantages you need to watch over for.

Some of this disadvantages are: Leverage can lead to more losses than you ever imagined if your positions are heading south when you open many of them thus becoming a risk ending up with losses. You can also make losses if the prices in the market move against your strategy thus enhancing the capability of getting losses. Also, any funding for leverage has to be paid with interest that is calculated and applied every day depending on the rate set by your broker. The costs estimated mount up to be a disincentive due to holding the exposure for the long term.

 

What is Leverage?

Leverage in Forex

Leverage is the ability for you to control something big using something small. Thus in the Forex trading, it can mean, if you have a small amount of capital, you can use it to control large amounts that are in the market.

 

How to Leverage?

Leverage in Forex

For the currency pair like USD/EUR, their exchange rates always fluctuate. These exchange rates fluctuate depending on market dynamics and different factors of the two separate economies in their respective countries or the global arena. The Forex traders come at this point. Just like in shares and the stock markets, they buy or sell a pair depending on how they speculate the currencies will do in the future hoping to maximize profits. The differences one is set to make regarding profits are usually minimal, mostly on the scale of 0.0001 of one unit. It cannot make any difference to anyone if they are trading in small amounts, but it would translate to something if the trading amounts were way larger. The trading amounts are called ‘Lots.’ One Lot is an equivalent unit of 100,000 units.

If transacting with the US Dollar (USD), very few Forex traders would be able to raise the capital for one Lot in USD which would be 100,000$ USD. The Forex brokers offer a ‘helping hand’ to lend you money to invest more and make greater profits and pay them back with interest. Brokers call this type of trading on margin. The brokers offer leverage as an amount of the trader’s capital to enable him to attain the amount needed for a Lot. These are also called ratios, and they are usually 400:1, 200:1, 100:1 and 50:1. They can be lower or higher than these depending on the brokers and the markets.

 

Leverage Margin

 

Leverage margin is the security amount a trader is required to have. Essentially the amount required of the trader for a leverage ratio. The leverage margin can be higher but not lower than the set ratio by a broker. For example; If a broker is offering a ratio of 400:1, the trader is required to have a margin of 250$ for one Lot of 100,000$. The margin is the leverage amount contribution of a trader.
The margin can also be referred to in percentages as below:

0.25% margin = 400:1

0.5% margin = 200:1

1% margin = 100:1

2% margin = 50:1

 

Profiting via Leverage

Leverage in Forex

When a trader transacts in Lots, he is set to gain profits (or losses). These are called “Pips.” One pip is equivalent to 0.0001 units or 10 units in every 100,000 units. So if a trader makes ten pips in a lot of 400:1 leverage ratio, his investment of 250$ would earn him 100$ profits. If he makes a loss of an equal ten pips, he would equivalently cause a loss of 100$ in his 250$ margin. Thus the saying “leverage is a double-edged sword.”

 

Conclusion

 

In Forex trading, even though a trader might have a considerable leverage, one is advised to go slow on the risks and trade amounts they can comfortably lose in case they are to suffer a loss in their trade. It is prudent to start low and increase as you gain experience in the markets to cushion yourself against high losses at the same time making a reasonable profit.Several mobile device applications can help you track and analyze your portfolio whenever and wherever. Some mobile apps like the MT4 (Metatrader 4) and Forex calendar have demo models to serve as a training platform before venturing into the real thing.