Leverage is the ability to use something small to control something big. Specific to foreign exchange (forex or FX) trading, it means that you can have a small amount of capital in your account, controlling a larger amount in the market.
Stock traders call this "trading on margin." In forex trading, there is no interest charged on the margin used, and it doesn't matter what kind of trader you are or what kind of credit you have. If you have an account, and the broker offers margin, you can trade on it.
The apparent advantage of using leverage is that you can make a considerable amount of money with only a limited amount of capital. The problem is that you can also lose a considerable amount of money trading with leverage. It all depends on how wisely you use it and how conservative your risk management is.
- Leverage involves borrowing money to trade securities, and while this can significantly increase your gains, it also means you could lose more money than you put into the investment.
- The amount of leverage you can use will be determined by your broker, but it could be as much as 400 times your total capital.
- The more leverage you use, the more you risk, so many professionals limit their leverage to 10:1 or 20:1.
You Have More Control Than You Think
Leverage makes a rather boring market incredibly exciting, but when your money is on the line, exciting is not always good, and that is what leverage has brought to FX.
Without leverage, traders would be surprised to see a 10% move in their account in one year. However, a trader using leverage can easily see a 10% move in one day.
Typical amounts of leverage tend to be too high, and it is important for you to know that much of the volatility you experience when trading is due more to the leverage on your trade than the move in the underlying asset.
Leverage is usually given in a fixed amount that can vary with different brokers. Each broker gives out leverage based on their rules and regulations. The amounts are typically 50:1, 100:1, 200:1, and 400:1.
- 50:1: Fifty-to-one leverage means that for every $1 you have in your account, you can place a trade worth up to $50. As an example, if you deposited $500, you would be able to trade amounts up to $25,000 on the market.
- 100:1: One-hundred-to-one leverage means that for every you have in your account, you can place a trade worth up to $100. This ratio is a typical amount of leverage offered on a standard lot account. The typical $2,000 minimum deposit for a standard account would give you the ability to control $200,000.
- 200:1: Two-hundred-to-one leverage means that for every $1 you have in your account, you can place a trade worth up to $200. The 200:1 ratio is a typical amount of leverage offered on a mini lot account. The typical minimum deposit on such an account is around $300, with which you can trade up to $60,000.
- 400:1: Four-hundred-to-one leverage means that for every $1 you have in your account, you can place a trade worth $400. Some brokers offer 400:1 on mini lot accounts but beware of any broker who offers this type of leverage for a small account. Anyone who makes a $300 deposit into a forex account and tries to trade with 400:1 leverage could be wiped out in a matter of minutes.
Professional Traders and Leverage
Professional traders usually trade with very low leverage. Keeping your leverage lower protects your capital when you make trading mistakes and keeps your returns consistent.
Many professionals will use leverage amounts like 10:1 or 20:1. It's possible to trade with that type of leverage, regardless of what the broker offers you. You have to deposit more money and make fewer trades.
No matter what's your style, remember that just because the leverage is there, that does not mean you have to use it. In general, the less leverage you use, the better. It takes experience to really know when to use leverage and when not to. Staying cautious will keep you in the game for the long run.
Frequently Asked Questions (FAQs)
Do you have to pay all of the leverage back when you trade forex?
You are required to pay back any leverage you use while trading. Leverage is debt just like any other type of loan, but unlike other types of debt, you may have some flexibility as to when you settle your balance. Your brokerage decides how much you can borrow and when you need to pay it back. At some point, you will have to settle your leverage debt.
How do you trade with leverage?
From a technical standpoint, trading with leverage is the same as trading without it. Leverage simply allows you to place larger orders, but the process of planning trades, placing orders, and managing positions is the same, no matter your leverage ratio.