What is Leverage in Forex Trading ?

The best advantage of the forex market that attracts a trader most is its leverage. Forex brokers offer up to 1:500 leverage. Leverage is the borrowed money from the broker on your initial investment to get a greater return.

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The best advantage of the forex market that attracts a trader most is its leverage. Forex brokers offer up to 1:500 leverage. Leverage is the borrowed money from the broker on your initial investment to get a greater return.

Only forex market allows this enormous amount of leverage among all financial markets. 1:100 leverage means, for every 1$ of your trading account you can trade 100$ in the forex market.

Difference between margin and leverage :

The term margin and leverage used to describe the different thing or situation. Leverage means how much money you are borrowing outside your initial investment.

On the other hand, the margin is your investment which controls the leveraged amount. For example, if your initial investment is $1000 and you are using 1:100 leverage then your leverage is $100,000, and your margin is $1000.

Advantages of leveraged trading :

A small investment looks like a big investment in case of forex trading due to an allowance of the high leverage ratio. This is an extremely attractive opportunity for traders. You can make a decent amount of money with a small investment if you can use this high leverage effectively.

For example, if you put $1000 in your account and trading without using leverage, then your gain or loss will be 10 cents per pip. This means if you get 100 pips profit then your gain will be $5 only. This is 0.5% of your investment.

On the other hand, if you trade with 1:100 leverage ratios then your trade value is $100000. Now, if you get 50 pips profit, then your profit will be $500.

Now, this is 50% of your investment. This makes a massive difference between leverage trading and non-leverage trading.

Disadvantages of leveraged trading :

The Major disadvantage of using leverage in trading is that it carries a high amount of risk. The higher the leverage the larger the chances of profit and loss are.

Leverage increases both profitability and risk. For example, your investment is $1000, and you are trading without leverage. In this case, your trade value is $1000.

Now if you lose 50 pips from your entry price, then your loss is $5. This is only 0.5% of your investment which is small and tolerable.

Now if you are trading with 1:100 leverage then your trade value is $100000. If you lose 50 pips on this trade, then your loss will be $500 which is 50% of your invested amount. This is how margin increases risk.

Margin call in Forex Trading:

A margin call is the action or steps taken by a broker to prevent the investor’s account from going negative due to an open position. This occurs due to excessive leverage use, improper planning, and excessive exposure due to greed.

Normally, a broker gives an alert or phone call when the equity drops near or at zero due to holding a losing position. Many brokers do not give any alert or phone call, and they simply close the losing position when your investment can not bear the possible loss.

This happens when your equity is less than your used margin. Using excessive leverage is the main reason to meet a margin call.

Summary:

Leverage should be used effectively as it increases both profitability and risk. Traders should use proper position sizing before using leverage.

The high amount of leverage can lead a trader to a margin call very easily. So before using it, one should know that how much loss he/she can tolerate and avoid margin calls.