What is Leverage – Forex Leverage
Nowadays each individual has access to Foreign Exchange market due to margin trading which is referred to speculation on the market by credit or leverage, provided by the broker for a certain amount of capital (margin) that is required for maintaining trading positions.
Leverage may be defined as the ratio of the client's funds to the size of the broker's credit. Usually, the size of leverage exceeds the invested capital for several times.
The size of Forex leverage is not fixed in all companies, it depends on trading conditions, provided by a certain company. IFC Markets offers leverage from 1:1 to 1:400. Usually in Forex market 1:100 is the most optimal leverage for trading. For example, if $1000 is invested and the leverage is equal to 1:100, the total amount available for trading will equal to $100.000. More precisely saying due to leverage traders are able to trade higher volumes. Investors, having small capitals prefer trading on margin (in other words using leverage), since their deposit is not enough for opening sufficient trading positions.
As it was mentioned above, the most popular leverage in Foreign Exchange market is 1:100, because high leverage, besides being attractive is very risky, too. Leverage in Forex may cause really big issues to those traders that are newcomers to online trading and just want to use big leverages, expecting to make large profits, while neglecting the fact that the experienced losses are going to be huge as well.
However, it is quite possible to avoid negative effects of Forex leverage on trading results. It is not rational to trade the whole balance, i.e. to open a position with the maximum trading volume. Another important technique is to use Stop Loss order, which will reduce the possible risks.
Example How Leverage is Used in Forex Trading
Account balance is $1000 with 1:100 leverage. You have decided to open a buy position with EURUSD pair with a volume of 10.000. The position is opened at price 1.0950. Stop Loss order is set at 1.0850 price. The required margin for this position is equal to €10 000 x 1/100 x 1.095 = $109.50. If you do not want to spend much time on calculating margin for all of your positions you may use our Margin Calculator. In case the market goes in different direction, your loss will equal to $100, since 1 pip value in EURUSD currency pair is $1 (for 10.000 volume), and the difference between your opened price and Stop Loss level is 100 pips. If you do not use Stop Loss order, you may lose pretty higher than $100, depending when you will close your position. Stop Loss order can be used both for Long and Short positions and its level is decided by you; that is why it is one of the best risk management tools in online trading.