If you have spent any time in forex research, you will have come across the term “leverage.” Traders may have discussed how to increase leverage or warned each other about the dangers. What is leverage in forex? And how do you use it safely? This article will cover the basics of leverage in forex. We will show you how leverage can be used for currency trading and how to make the most of it.
What is leverage in Forex?
Leverage is the ability to trade forex that’s worth more than your brokerage account. It’s simply the ability to borrow money from your forex broker in order to make larger trades.
Brokers calculate leverage by comparing the amount of dollars in your account to the amount you can trade with. The most common leverage ratio for forex is 1:100. You can purchase currency with 100:1 leverage if you have $100 in your account. Because currency prices are usually small, leverage is the best way to invest in forex markets. Let’s look at an example.
Example of leverage
Let’s suppose you have $1,000 in your forex bank account. Your belief that the Canadian dollar will rise in value means you put your entire account into Canadian dollars. You can buy $1 to get CA$1.327. This means you will add CA$1,327 to your account.
The U.S. dollar’s value is dropping relative to Canadian dollars. A $1 equals CA$1.320. The exchange of your money results in a return of approximately $1,005. Your total profit will be about $5, before broker fees.
Because a currency’s value may fluctuate by a small percentage every day, leverage is essential. You can see the profit potential of using 1:100 leverage to make $500 instead of $5.
What is Margin in Forex Trading?
You may have heard of traders trading forex on the margin if you have ever traded stocks.
Margin trading in forex is, in general, the same as using leverage. Margin percentages are expressed differently by brokers. The margin standard is used by brokers to express the value of leverage. It usually means (dollars that you can trade with): (dollars in your brokerage accounts). If your broker offers 2:1 leverage, that means you can trade with the power to $2 for every $1 in your brokerage account.
What Leverage should I use?
Forex traders love the currency margin as they don’t have to invest thousands of dollars in order to start making large profits. But, for novice traders, leverage can be extremely dangerous. 100:1 leverage can result in 100x the losses. You can make huge profits from a small investment but it is also possible to wipe out your initial investment.
It is therefore crucial to choose the right level of leverage when trading. Although you might be able get leverage as high as 1,500:1, it is not a good way to trade and can quickly lead to debt. We recommend starting with 50:1. 100:1 is the most popular forex leverage rate. This level of risk is lower and requires a full price movement of 2% to empty your initial investment. It’s not common for currency movements. You can always increase your leverage as you gain experience.