08. What is Leverage in Forex?
When you start learning about forex trading, you will come across a term called “Leverage”. But you don’t know what is leverage in forex trading. So, let’s provide you an easy explanation on what is leverage in forex.
What is Leverage?
“Leverage is the loan or ability to use a large amount of capital than your own capital through the help of your broker”
Leverage is like a loan from the broker. It allows you to control a larger amount of money than you actually have. It is expressed as a ratio. Different levels of leverage are available depending on your broker.
Let’s say, you want to trade with a $100,000 capital in the forex market. Your broker offers you a deal. They will set aside $1,000 from your account to make this trade happen. This relationship between the amount you control and the money you put down is a ratio (in this case, it’s 100:1). So, you’re controlling $100,000 with just $1,000 of your own money.
So, how does this help you?
If this $100,000 goes up in value to $101,000. You’ve made a $1000 gain. If this was your actual investment, you would have gained only 1% ($1000 gain from $100,000 investment). This is 1:1 leverage which is really next to nothing, right?
But, with the help of your forex broker whatever the amount of your actual investment is, you will be able to control a larger position with a smaller account size. It will amplify your potential profits drastically. However, it’s important to remember that although leverage increases potential profits, it also increases the risk of losses.
How leverage works in forex:
Here are two examples to help you understand how leverage works in forex:
01. Positive Outcome:
- You have 10,000 euros as your capital.
- Your broker offers 1 to 100 leverage.
- You can control a trading capital of 1 million euros.
- If you buy the euro against the US dollar at 1.3055 and sell it later at 1.3155, you could almost double your capital.
02. Negative Outcome:
- Same trader, same 10,000 euros capital.
- Has 1 to 100 leverage.
- Buys the euro at 1.3055 but sells it at 1.3005, losing almost half of the capital.
The main point is that leverage can amplify both profits and losses. So, it’s important to use it wisely to avoid magnifying your losses.
This is what you learned today-
- Leverage is the ability to control a large capital; loaned by your broker.
- How leverage works
