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 vital role in Forex trading and is offered by the broker. Let’s explore the term, its advantages, and its disadvantages.
What is leverage?
Leverage means the use of something to maximum advantage. In finance, leverage is using borrowed money to invest.
What is Leverage in Forex Trading?
Leverage in forex is the ratio of the trader’s funds to the size of the broker’s credit. Brokerage accounts allow the use of leverage, the borrowed funds to traders to 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. Forex trading leverage is the ratio at which a small investment in your trading account controls a larger investment operating in the market. This difference in the two capitals is also known as the trading on margin in the stocks or forex market. There is an interest charged on this margin in the stocks market, but such is not the Forex market. Traders are not required to pay any interest on this margin irrespective of their 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?
Leverage 1:100 means that for every $1 in the trading account, traders can trade in the market up to $100 in value and the required margin is 1%. The lowers the margin requirement, the greater amount of leverage that can be used on each trade. In the foreign exchange markets, the leverage ratio is commonly as high as 1:100.
Leverage 1:30 means that for every $1 in the trading account, traders can trade in the market up to $30 in value and the required margin is 3.3%.
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 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 to look forward to. Everything was slow, but leverage has changed it. Thus, the benefit of leverage is that it allows you to quickly invest more money in the market to fetch more profits.
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, then the Margin Required of Total Transaction Value will be 1.00%. The margin requirement for 2% is 1:50 leverage.
The brokers fix leverage amounts 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 you can use $50 to place a trade in the market for every dollar in your account. 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 the higher side. All the brokers do not offer this leverage. You can usually get this if 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?
High leverage amounts do not blind professional traders. They generally use 20:1 or 10:1 leverage and make several small trades. This safeguards their capital. If you want to take full advantage of leverage, do not invest 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 establish 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. Many aspects govern whether there will be gains or losses. Many traders, especially the new ones, aim for higher leverage, like fx trading 400 leverage, hoping to make more profits. Higher leverage does not necessarily translate into higher profits. It can lead to equally high losses. We would suggest you aim for the leverage that you can easily manage and keep in mind that the chances of making losses are real. Instead of having an optimist approach, have a realist approach towards leverage and Forex trading.