What is Leverage in Forex
What is Leverage
Leverage in Forex is the ratio of the trader's funds to the size of the broker's credit. In other words, leverage is a borrowed capital to increase the potential returns. The Forex leverage size usually exceeds the invested capital for several times.
The size of leverage is not fixed at all companies, and it depends on trading conditions provided by a certain Forex broker.
So, Forex Leverage is a way for a trader to trade much bigger volumes than he would, using only his own limited amount of trading capital.
Nowadays, due to margin trading, each individual has access to Foreign Exchange Market which is referred to speculation on the market by credit or leverage, provided by the broker for a certain amount of capital (margin) that is required for maintaining trading positions.
But wait – there’s more to know about trading leverage ...
How to Choose the Best Leverage Level
Which is the best leverage level? - The answer to the question is that it is hard to determine which is the right leverage level.
As it mainly depends on the trader's trading strategy and the actual vision of upcoming market moves. That is, scalpers and breakout traders try to use high leverage, as they usually look for quick trades, but as to positional traders, they often trade with low leverage amount.
So, what leverage to use for forex trading? - just keep in mind that Forex traders should choose the level of leverage that makes them most comfortable.
IFC Markets offers leverage from 1:1 to 1:400. Usually in Forex Market 1:100 leverage level is the most optimal leverage for trading. For example, if $1000 is invested and the leverage is equal to 1:100, the total amount available for trading will equal to $100.000. More precisely saying, due to leverage traders are able to trade higher volumes. Investors having small capitals prefer trading on margin (or with leverage), since their deposit is not enough for opening sufficient trading positions.
As it was mentioned above, the most popular Leverage in Forex is 1:100.
So what’s the problem with high leverage? - Well, the high leverage, besides being attractive is very risky too. Leverage in Forex may cause really big issues to those traders that are newcomers to online trading and just want to use big leverages, expecting to make large profits, while neglecting the fact that the experienced losses are going to be huge as well.
How to Manage Leverage Risk
So, while leverage can increase the potential profits, it also has the capability to increase potential losses as well, that is why you should choose carefully the amount of leverage on your trading account. But it should be noted that though trading this way require careful risk management, many traders always trade with leverage to increase their potential returns on investment.
It is quite possible to avoid negative effects of Forex leverage on trading results. First of all, it is not rational to trade the whole balance, i.e. to open a position with the maximum trading volume.
That's not all ...
Apart from that, Forex brokers usually provide such key risk management tools as stop-loss orders that can help traders to manage risks more effectively.
Here are the basic points to manage the leverage risks properly:
- using trailing stops,
- keeping positions small
- and limiting the amount of capital for each position.
So, Forex leverage can be used successfully and profitably with proper management.
Keep in mind that the leverage is totally flexible and customizable to each trader's needs and choices.
Now having a better understanding of Forex leverage, find out how trading leverage works with an example.
Forex Leverage Example
How does Leverage Work Account balance is $1000 with 1:100 leverage. You have decided to open a buy position with EURUSD pair with a volume of 10.000. The position is opened at price 1.0950. Stop Loss order is set at 1.0850 price. The required margin for this position is equal to €10 000 x 1/100 x 1.095 = $109.50. If you do not want to spend much time on calculating margin for all of your positions you may use our Margin Calculator. In case the market goes in different direction, your loss will equal to $100, since 1 pip value in EURUSD currency pair is $1 (for 10.000 volume), and the difference between your opened price and Stop Loss level is 100 pips. If you do not use Stop Loss order, you may lose pretty higher than $100, depending when you will close your position. Stop Loss order can be used both for Long and Short positions and its level is decided by you; that is why it is one of the best risk management tools in online trading.
How to Calculate Leverage in Forex
To measure the leverage for trading - just use the below-mentioned leverage formula.
Leverage = 1/Margin = 100/Margin Percentage
Example: If the margin is 0.02, then the margin percentage is 2%, and the leverage = 1/0.02 = 100/2 = 50.
To calculate the amount of margin used, just use our Margin Calculator.
You can read more about What is Leverage here
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