What is forex leverage? How leverage works in forex market?

EducationNovember 11, 2021

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Leverage in Forex is considered a high-risk form of trading. However, this is just how an amateur investor views leverage. This tool can be very profitable in a short time. So, what is leverage in Forex? How does leverage work? Let’s learn about the issues of leverage through the article below.

What is Leverage in Forex?

In trading and investing, the term leverage is used when an investor uses a small amount of money to control a more significant amount. This is the ratio of money customers convert to the allowed volume. Leverage size in Forex often exceeds the invested capital several times to several hundred times.

To use leverage, you need to register your account. This account is called a margin account. Upon successful registration, the broker will lend you a large amount of cash to buy the property. Leverage in Forex is expressed as a ratio like 1:2. 1:5, 1:100, 1:500, 1:1000,…

For example: When holding 100$ in the margin account, you can make transactions with different values ​​such as 200$, 500$, 1000$, etc.

In particular, leverage is directly related to the concept of margin trading in financial investment. Therefore, Traders need to understand the idea as well as how to calculate Margin correctly. According to the actual survey, the higher the leverage, the lower the Margin.

Example: You need to open a trade worth 1000$. At that time, the minimum deposit or Margin level will be 200$. Thus, the broker will use $ 800 to lend you.

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How does leverage work in Forex?

After understanding what leverage is in Forex, you can continue to learn about how it works. In the following, we will explain how the tool works by comparing leveraged and non-leveraged trading.

Assume: Your margin account is currently $200. The account leverage is 1:500. Then:

Case 1: Trade without leverage

Let’s say you are ordering 0.2 lots of USD/CAD for 20,000 USD. The minimum deposit is now $20,000. Your account is currently 2000$. As a result, your transaction is not executed.

You will then reduce your trading volume to 0.01 lots for 1000 USD. The corresponding minimum deposit is 1000$.

  • If the price goes up and your trade wins by 100 pips, then the order’s profit will equal the order volume multiplied by the number of winning pips and the pip value.
    • Specifically: 1000 x 100 x (0.0001/1.13200) = $8.83
    • In which: 1.13200 is the exchange rate of USD/CAD pair at the time of closing the order.
  • Conversely, if the price falls and your trade loses 30 pips, then the amount of the loss is equal to the order volume multiplied by the number of pips lost and the pip value.
    • Specifically: 1000 x 30 x (0.0001/1.11900) = $3.36
    • In which: 1.11900 is the USD/CAD exchange rate at the time of closing the order.

Case 2: Trading using leverage

What is Leverage in Forex? How does leverage work in Forex? How much leverage should be used in trading? Pros and cons of leveraged

The exact deposit amount is 1000$, but you can use 1:100 leverage. Then, the successful trading volume will now be one lot.

  • If the price rises and the trade wins 100 pips, the order’s profit will be: 100,000 x 100 x (0.0001/1.13200) = $883.
  • If the price falls and the trade loses 30 pips, the order’s loss amount is 100,000 x 30 x (0.0001/1.11900) = $336.

Compared to not using leverage, you are allowed to trade with an order worth 100 times. Same 1:100 ratio and 1000$ deposit, but profit maximization up to 100x. At the same time, if the trade fails, the amount of the loss is also increased by 100 times. Therefore, the leverage strategy in Forex is always considered a double-edged sword.

How much leverage should be used in trading?

Not only wondering what leverage in Forex is, but traders often ask the question, “Should I use leverage or not.” In fact, given the nature of the forex trading market, researchers will not give a specific answer. Instead, they will tell you “how much leverage should be used.”

If you are a new trader with limited investment capital, you should use a low leverage ratio. Maybe, this is a way to help you experience and summarize the best investment strategies. After gradually familiarizing yourself with the market, you can execute big trading strategies without fear of risk.

According to experience from brokers, new investors should choose a leverage ratio of no more than 1:100. During the trading process, you can gradually increase the leverage ratio accordingly.

Professional Traders always aim for high profits. Therefore, they will choose a higher level of leverage to achieve a decent profit.

Pros and cons of leveraged

What are the strengths and weaknesses of the leverage strategy in Forex? Indeed, this is what many investors are interested in. In particular, new traders need to understand the nature of this tool.

Pros

Here are the outstanding advantages of leverage in Forex:

  • Optimizing profits on small capital: It can be seen that this is the most significant advantage of leverage. With only a small amount of initial money, investors can make transactions with a much larger value. That is, instead of paying the total amount for the trading period, you only need to pay a tiny portion. This tool is very suitable for investors with little capital and inexperience.
  • Low Cost: Usually, you need to have at least 1000 USD to participate in the Forex market. However, the leverage tool only requires Traders to own capital from 1 USD. That is to say, the cost of leveraged trading in Forex is meager.

Cons

As mentioned, leverage in Forex is like a double-edged sword. Besides the remarkable advantages, it has a rather severe drawback. The element of risk and loss amplification / as much as leverage helps increase profits, it will amplify losses when trades fail. Therefore, you need to consider very carefully in choosing the leverage ratio.

Just now, you have been learned what leverage in Forex is. In addition, there is some information related to leveraged instruments. Please refer to and study carefully the trading strategy to achieve high efficiency.

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