What is Leverage in Forex Trading?

Whether you are a broker, full time, or part time day trader, everyone has the same reason for getting into forex…. To make MONEY!  Are you making as much as you would like to be? Probably not.  Want to learn how to make more?  Of course you do.  Keep reading to find out how Forex Leverage can be used to give you the healthy profits you’ve been looking for.

Leverage is essentially a loan that is provided to an investor from a broker who is handling their Forex account. When an investor chooses to invest in the Forex Market, they must open a Margin Account with a broker. Typical leverage amounts range from 50:1 to as high as 400:1, depending on the particular broker and how large the position is that the investor is trading. Normal trading is done based on 100,000 units of currency, the leverage usually provided for this size trade would likely be 50:1 or 100:1.Leverage of 200:1 is commonly used for $50,000 or less.

No matter what type of business you’re in, having leverage is a big advantage and can mean more profits. Forex leverage is no different and the better you can perfect and make the most of yours, the more you stand to make.

So what exactly is Forex leverage?

If you don’t know what Forex Leverage or Margins are, here are brief definitions:

“Margin” in Forex is the minimum required balance to place a trade.  When you fund a FOREX trading account, the money in your account is your margin, and acts as total collateral for your trades.

Leverage basically means the Maximum Amount arranged between you and your Broker that they will lend against your capital (margin).

Leverage is usually quoted as a ratio such as 100:1, 200:1, or 400:1.  Simply put, a ratio of 100: 1 means that you can trade 100 units of currency while only putting up 1 unit. In other words you would only need to put up $1,000 in order to trade $100,000.

The reason successful forex currency traders use leverage to make their profits skyrocket is that a single pip is low and you have to trade large lots of currency to make a profit. To maximize your profits in Forex trading, you don’t necessarily need to trade with a standard account. Many beginning traders cannot afford to. However, if you believe you have a good forecast on the market, you can trade more than one lot. Lets say you made a successful trade that earned you three hundred pips and you had purchased ten lots of that currency, in a mini account you would have put up $1000 of your own money—but earned a profit of $3,000 (three hundred pips times ten lots). In a standard account, you would have put up $10,000—and earned $30,000.

The number of lots you can trade depends upon the margin in your account (not the amount you deposited). Included in that are any open trades you have running, taking into account any profits or losses you may incur.
With Forex market being so liquid, brokers can offer you this extremely high leverage because they almost never have to worry about you owing them money back if the trade goes bad.
Margin call policies at many brokers are usually designed to issue a margin call on your account well before a negative balance occurs.

With some brokers, however, the market may move against your position too rapidly, and you may incur a total loss of your funds and even a negative balance. You should always check your broker’s margin policies ahead of time to know whether this is a possibility.

Leverage gives the trader the ability to make huge profits, and at the same time keep risk capital to a minimum. Traders must remember that in forex, leverage is a double-edged sword: while it can multiply your gain potential exponentially, it can equally magnify your loss potential. Abuse it and you might find yourself broke in no time.

Leverage in the context of currency trading means using a smaller amount of a currency for a position instead of putting up the full amount. This is the same as trading on margin and it can be an extremely risky thing to do. Knowing what you’re doing and knowing the odds is a big part of being successful with using Forex leverage properly, but there are ways to make the odds work in your favor.

In order to trade $100,000 of currency, if the margin is 1% an individual will need to deposit $1000 into their margin account. The leverage generally provided on a trade like this is 100:1. This amount of leverage is drastically more than the 2:1 leverage most often provided on equities, and the 15:1 leverage usually provided by the futures market.

While a leverage of 100:1 seems quite risky, the risk is dramatically less when you account for the fact that currencies rarely change more than 1% during a given trading day. Brokers would not offer as much leverage if the fluctuation was as high as equities and futures.

Which Leverage is Best in Forex for Beginners?

There is an ability to earn substantial profits using leverages, however, leverages can also work against an investor. For example, if the currency moves the opposite direction you thought it would leverage will multiply the potential loss by the same factor as it would multiply the gain.

Forex traders usually take advantage of stop and limit orders that reduce the risk and can prevent you from suffering a huge loss.Many people starting out in Forex trading don’t completely understand leverage concepts.

Basically, if you start out with capital of $5000 and you use a 1:50 leverage you can have a trading value of $250,00. This seems great however, a move as little as 2% in the opposite direction of your position will effectively wipe out your capital. Using a smaller leverage like 1:20 for instance can help you when starting out and keep you from losing too much too fast.

A leverage of 1:20 means your $5000 can control $100,000 of trading capital. If for example you are trading the EUR/USD pair and you enter a trade on the long side, in other words, that the USD will decrease value against the Euro. Say the EUR/USD is currently 1.455 and you use the whole $100,000 to exchange for Euros, you effectively get 68,728 Euros. If the trade goes in your favor and the USD depreciates by 1% your capital will increase by 20%. For example, if the EUR/USD rate goes from 1.455 to 1.469 you can exchange your 68,728 Euros for USD of $101,000 which is a $1000 profit. Since you started with real capital of $5000, $1000 is equal to a 20% gain. If the trade goes the opposite direction by that same 1% your account would lose $1000.

When trading in Forex it is imperative to understand the leverages and what they mean to your real trading capital. Beginners should always use practice accounts to learn the system and get a feel for how the process works. Take advantage of all of the tools and tracking information that is made available and be careful about using leverages that are too high. Some brokers offer up 1:400 leverages, however,this high of leverage can wipe out your entire trading account quite quickly with even a small change in the opposite direction of your predictions.

Generally speaking the speculator loses in any high value (and high risk) leverage trade. The person who wins is the broker, it’s just how the statistics play out. The good news? You can still use “low leverage” to be successful and trade with much less risk. It also doesn’t hurt to do your homework and thoroughly examine any risk, no matter how big or small, before going in for the kill.

If you couldn’t tell by now making the most of forex leverage can be extremely difficult and it’s more of a science than anything. If you’re a newbie or intermediate it’s probably not a good idea to attempt using this method but if you’re closing in on the advanced level of trading there are some great guides online you can take advantage of to learn more.

Patrick Mahinge is a full time forex trader, money manager, and consultant to major financial funds. At only 28 years old he is widely considered an up and rising star in the forex trading community and is known for his simple time proven techniques. Since the founding of KenyaForexFirm.com in 2014, his forecasts have been uncannily accurate and his subscribers have reaped the benefits. KenyaForexFirm.com is Patrick's attempt to share his wisdom and knowledge about Forex Trading so traders can see through the clutter and get straight to the core of profitable trading.

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