What is Forex Leverage? How Does Forex Leverage Work?
Leverage is a term that gets thrown around often in the investing and financial worlds.
Because of this, the exact definition when it comes to forex specifically is sometimes muddied in the waters a bit.
Simply put, forex leverage is essentially money borrowed from the broker that allows you to make substantially bigger returns on your investment.
It is the ratio of the trader’s (you) funds to the amount of credit a broker allows you to trade with.
When you just start out trading, you probably don’t have thousands of dollars in your trading account (I certainly didn’t).
Forex brokers are very aware of this and actually make it easy for you to trade with a bigger chance of returns by offering you leverage.
Trading leverage allows you to make larger profits from the fluctuations in a currency that you are trying to extract profits from.
Leverage gives you the ability to trade higher volumes than you might otherwise be unable to.
Luckily for us, the leverage available for forex traders is actually much higher than most other markets.
Forex traders are able to leverage their accounts through a variety of ways, including futures, options and margin accounts.
Traders have the option of utilizing leverage usually after they have deposited the minimum necessary amount in their account, which is called margin.
Once you have deposited the ‘margin’ then you will be able to access and maintain a leveraged trading position.
It’s important to note that the specific value of the margin and leverage available to you varies widely depending on which forex broker you are trading with.
Here’s a short but great informative video from ‘Etienne Crete’ on Youtube about best forex leverage.
How Forex Leverage Does Work
To make this easier to understand, I will give an example.
There are different leverage ratios available, the most common one being 100:1.
For the sake of this example, I’ll use 50:1.
With leverage of 50:1, this means that $1 in your trading account is able to enter a position of $50.
With leverage of 50:1, $2 in your forex account would give you the ability to enter a trade with $100.
Let’s say the forex leverage is 100:1.
Following the same principle, with leverage of 100:1, $1 in your account allows you to trade with $100.
With leverage of 100:1, $2 would allow you to enter a position with a buying power of $200.
The range of forex leverage usually stays within either 50:1, 100:1, or 200:1. This obviously depends on not only the broker you are using but the size of your trading position.
If you are given leverage of 100:1 but have a million dollars in your account, it’s a lot more dangerous for a broker to provide that amount of buying power as compared to someone who has a few hundred dollars.
To continue this example, let’s pretend we are trading the popular USD/CAD (US dollar against the Canadian dollar) currency pair.
Buying or selling $100,000 of USD/CAD without any leverage requires a trader to front an entire cost, which is $100,000, the full position.
Let’s say the trader is granted a 50:1 leverage. This means that only $2,000 worth of the trader’s account would be needed to open and maintain this $100,000 USD/CAD position.
Forex leverage makes traders’ lives a lot easier by enabling them to make exponentially more money without having to actually have the funds they are trading with.
This is another reason why choosing the right forex broker is very important and can help you in the long run, especially when you are more experienced and have the capability to start making big trades and even bigger profits.
Dangers of Forex Leverage
Since leverage grants the forex trader to trade with volumes that you do not presently have in your account, it can also act as a double-edged sword.
While your potential profits are magnified, so are your potential losses.
Because of this, it’s crucial to make sure you know what you are doing and are not trading with volumes of currency that you don’t know what to do with.
Forex, while offering some of the biggest returns compared to other forms of day trading, can also lead to some of the biggest losses, which is why it’s usually wise to implement stop losses in your trading strategy.
Make sure you have a good understanding of forex money management so you can continue trading for years to come.
Learn to Trade Forex
Using forex leverage in order to increase the number of profits you make while trading is a great way to grow your forex account and gain capital faster than you would without leverage.
As mentioned in this article, the benefits of forex leverage can also be your downfall. Forex leverage can lose you more money than you even have in your account, which is certainly not the desired outcome from forex trading.
As always, the goal is to trade and make money every day so as to make a living. It is impossible to make a steady living from trading if you are losing more money than you are earning.
Because of this, forex leverage is recommended as a strategy for those who are already familiar with the basics of the forex market and want to capitalize on their skill level without needing a large amount of capital to start.
If you are still a novice forex trader and do not know how to make profits every day, it is important you invest in a course that will teach you exactly how to make good trades no matter what the markets are looking like.
There’s a reason professional traders are able to make big money no matter how unfavorable the markets are performing.
If you are not at that level yet, I suggest taking a look at my write up of the best forex course here. It will seriously teach you everything you need to know and more about how to extract profits from the foreign exchange market consistently.
And, if you haven’t already, feel free to grab our Free Intro to Forex Trading PDF which has tons of information on how to start trading forex. Check out the sidebar to the left of this post to get your copy sent straight to your email today.