One can venture into the world of Forex trading with limited investment. Some Forex brokers even let their clients open an account with a minimum deposit as low as $100. Whether you have limited capital or not, everyone wants to use a higher sum than their actual investment to make more profits. This is possible with leverage.
Leverage plays a very important role in Forex trading and is offered by the broker. Let’s explore the term, its advantages, and its disadvantages.
What is Leverage in Forex Trading?
Leverage is the ability to use a small amount of capital in traders’ accounts controlling a larger amount in the market. Leverage is the ratio of the trader’s funds to the size of the broker’s credit. Brokerage accounts allow the use of leverage through margin trading or in other words, brokers provide the borrowed funds to traders so they can increase trading positions. The leverage ratio can amplify both profits as well as losses.
For a Layman, leverage would be a small thing that can be used for bigger purposes. In Forex trading, it is the ratio at which a small investment in your trading account controls a larger investment that is operating in the market. This difference in the two capitals is also known as the trading on margin in the stocks or forex market. In the stocks market, there is an interest charged on this margin but such is not the case in the Forex market. Traders are not required to pay any interest on this margin irrespective of your credit type and account type. Your Forex broker will offer a margin to you that you can use to trade.
You can read more details about what is leverage in forex in our article.
What is instrument leverage 1:100?
So, leverage we can describe as the ability to control a large amount of money using very little of your own. But, what is 1:100 leverage meaning?
In the foreign exchange markets, the leverage ratio is commonly as high as 1:100. Leverage 1:100 means that for every $1,000 in the trading account, traders can trade in the market up to $100,000 in value.
What are the Benefits of Trading Using Leverage?
Leverage is an important feature offered by Forex brokers. It helps you trade with higher capital and make more profits. For example, consider operating with a 1:100 leverage. This is the most common leverage in Forex. It means that with an investment of $1, you will be operating an investment of $100 in the market. $1 is your money and $99 is the borrowed money, your leverage. Since your operating amount is $100, you will be able to make more profits. This borrowed money will be sponsored by your broker and needs to be repaid.
Before leverage was introduced in the Forex market, a 10 % movement in the account for a year was something to look forward to. Everything was slow but leverage has changed it. Thus, the benefit of leverage is that it allows you to invest more money in the market that can fetch more profits quickly.
How to calculate leverage and trading margin?
The main leverage formula is:
Margin-Based Leverage Ratio = Total Value of Transaction / Margin Required
In this case, if the Margin-Based Leverage Expressed Ratio is 1:100 than the Margin Required of Total Transaction Value will be 1.00%. The margin requirement for 2% is 1:50 leverage.
Leverage amounts are fixed by the brokers at their discretion. Different brokers have different ratios to offer to their clients. Their terms and conditions also vary. The most popular ones are explained below:
- 50:1 – This leverage is on the lower side and means that for every dollar in your account, you can use $50 to place a trade in the market. For example, if you have a deposit of $100 with a broker, you can trade with an amount that 50 times higher. In this case, $5000.
- 100:1 – As mentioned earlier, this is the most popular leverage in Forex trading and is usually offered to standard lot account holders. You get to trade $100 for every dollar in your account. As the minimum deposit amount for a standard account is typical $2000, you can trade with an amount equivalent to $200,000.
- 200:1 – This leverage amount is offered to mini account holders with a typical minimum deposit of $500. With this leverage, you can trade 200 times the amount in your account. If you only have a minimum deposit, you can still control $100,000 in the market.
- 400:1 – This leverage is on a higher side. This leverage is not offered by all the brokers. You can usually get this is you are holding a mini account. As the minimum deposit is around $500, you can control a sum of $200,000 in the market.
How to Handle Leverage Professionally
Professional traders are not blinded by high leverage amounts. They generally use 20:1 or 10:1 leverage and make a number of small trades. This safeguards their capital. If you do want to take full advantage of leverage, do not invest all the amount in one trade. Move gradually and aim for consistent returns rather than a miraculous one-time deal. These professional tricks followed by veteran traders and investors will help you in establishing yourself as a Forex trader.
The best option for traders is to have brokers that can offer various leverages. In that case, the trader can change the leverage ratio in the broker’s website dashboard.
A Word of Advice
Leverage is nothing but borrowed money. You can make more profits with it but it can take an ugly turn as well. It only promises extra investment, not profit. There are many aspects that govern whether there will be gains or losses. Many traders, especially the new ones, aim for higher leverage, like fx trading 400 leverage, with the hope of making more profits. Higher leverage does not necessarily into higher profits. It can lead to equally high losses. We would suggest you aim for the leverage that you can easily manage and do keep in mind that the chances of making losses are real too. Instead of having an optimist approach, have a realist approach towards leverage and Forex trading.