The ratio of invested amount relative to the trader’s actual equity / deposited funds is known as leverage. In forex, leverage is the trader’s best benefit – and it is to be treated with caution and understand the meaning of the ratio chosen. Your account may have a limitation on the ratio of leverage which might be allocated for you. Leverage is expressed in ratios.
The market is very diverse and acquires a lot of attention in understanding the terms used. Leverage can also be explained as borrowed capital, this borrowed capital is used to invest in something – this money is borrowed from a broker.
Forex Trading as the biggest market as the highest leverage of all markets. It is also important to note your leverage most of the type will be based on the broker’s margin requirement.
Margins in Percentages
- 5% Margin gives a maximum of 20:1 leverage
- 3% Margin gives a maximum of 33:1 leverage
- 2% Margin gives a maximum of 50:1 leverage
- 1% Margin gives a maximum of 100:1 leverage
- 50% Margin gives a maximum of 200:1 leverage
- 25% Margin gives a maximum of 400:1 leverage
Many would often refer to leverage as “a double-edged sword” or “a two-way street”. Leverage will always give traders an advantage to make tons of potential profit, and conversely, a huge potential loss. It is important to understand all the tools involved in forex to minimize the risks thereof. Because Forex is leveraged – one need to familiarize themselves with Stop Losses, Take Profit as well as other orders to help minimize the risks and yet draw you a huge amount of profit should the market turn on your favor.
Similarly, if you had a leverage of 1:500, for every US$1, the broker will invest US$500 for you.
Leverage plays a bigger role when it comes to currency trading, there are a number of techniques working together for a successful execution in forex. There are pips and lots which will be discussed in the next topic.
There are a number of advantages to using leverage. Because to execute a 1 standard lot in forex requires 100 000 units of currency – makes it impossible for an amateur traders, even for professionals, what leverage does, it gives you an opportunity to execute a US$100 000 trade with a minimal amount of money – even with just a $1000 deposit, giving you more chance of making even more money and or lose it. In forex, either you win a trade or lose a trade, that’s what you should come in terms with when trading.
Even professionals have losing trades, and so leverage is to be treated with caution and understand the basics and method that could be used to minimize the risks involved.
One cannot simply eliminate risks involved, NO! The best chance you have is to minimize the risks.
The margin requirement can be met with money as well as profitable open positions on your trading platform. The equity in your account is the total amount of cash added to your profitable open position minus/subtracted by losing positions.
If you use 100% of your margin for trades, which highly not recommended, Margin Call may happen. You’ll notice this as your broker closes your positions until there’s enough margin to cover your losses.
The simplest way to calculate Margin required is:
Required Margin = Trade Size / Leverage * Account Currency Exchange Rate
Scenario: You purchase a 100 000 units of EUR/USD with a leverage of 100:1, with the currency rate at 1.14807