What is forex leverage
So, you made a decision to earn money by trading in the Forex currency market. Now you have
to choose a broker and open his personal account. An important condition that you should pay
attention to when choosing is the leverage that you can use when conducting trading operations.
What is it, how it can affect profitability and why there is so much talk around this concept? We
will try to answer these questions in a simple and detailed manner, but first we'll tell you in detail
what the leverage on Forex is.
Leverage: what is it?
The brokerage office in which you open an account is interested in attracting traders. The trader,
in turn, is interested in attracting loans for trading operations. Thus, there are mutually beneficial
demand and supply. Since the trader's account has its own funds, and the liquidity of the hard
currency being acquired is absolute, the broker easily provides a loan within the trader's ability to
cover the probable losses with his own funds.
Leverage is the ratio of a trader's own funds on his account to the borrowed money allocated to
the broker. That is, if the leverage under the contract is 1:50, then for $ 1 of own funds there are
50 dollars of broker allocated for lending.
The leverage for novice traders is usually 1:100. Leverage depends on the experience and
successful trading of the trader: the more successful the trader, the less is his leverage (1:200,
Leverage as a way to increase revenue
So, the leverage determines the amount of the loan provided by the broker to the trader, to
increase the volume of trades and, accordingly, the return on investment. A broker, crediting a
trader, does not bear responsibility with him in case of losses of the trader from the trade.
Insurance from this broker is simple and very effective: as soon as the trader's account runs out
of money sufficient to cover the broker's losses, the lending ceases.
Balance for leverage
The condition for a trader's loan is the presence on his trading account of his own funds, which
are called margins. The trader can use the leverage only if such minimum capital is available. At
different brokers the sum of such minimum capital is different.
Loan amounts of various brokers
The leverage of various brokers may be different. Leverage 1: 100 means that the broker
allocates a trader a loan, which exceeds the amount of the trader's own funds by 100 times.
The maximum leverage is determined exclusively by the broker and can reach 1: 500. Lending in
volumes of this order, as a rule, is not necessary, since most traders are well off by leverage of 1:
100. In the course of trading, it is necessary to monitor the results of trades for each transaction.
A common mistake of many novice traders is to control the balance of the account without
monitoring the profitability for each transaction. This approach is incorrect, because it can lead
to uncontrolled destruction of the trader's account.
Reducing the risks of money management
Proper management of the capital allows the trader to build a trading system, the risk of which
does not depend on the size of the leverage. This is explained by the fact that the risk on
transactions is calculated as a percentage of the total amount. The total amount of the transaction
in this case will not exceed 2%. Let us show this in a simple example.
Recall that trading on Forex is not free. For each transaction, the trader must pay the broker a
certain amount under the contract in the form of a commission or in the spread. Actually, such
payments constitute the income of a brokerage company in trading on Forex.
The costs of the trader directly depend on the size of the leverage: the higher the leverage, the
more they are. Since trading costs are covered by the trader from own profit, it is necessary to
choose the optimal leverage.