A basic cash trading account limits your investment to the amount of money you have available in your account at any given time. If you open a position and the market turns against you, there is potential that you will lose some or all of the money invested.
That sounds simple, but there is a problem with this on the Forex market: it will take a long time to earn substantial profit unless you have a lot of money to invest upfront. Most traders don't have hundreds of thousands of dollars to invest when they first start trading, and it would take them a long time to accumulate that amount in profit due to the nature of currency value changes.
If you need Forex leverage and margin explained in simple terms, keep reading this page. You can also read our page on Forex margins to gain a complete understanding of how these concepts fit together.
Leverage is expressed as a ratio. For instance, United States trading accounts are governed to a maximum of 50:1. This means U.S. traders can invest up to $50 for every $1 that they fund into their account upfront. If they only have $50 to invest starting out, they can place leveraged trades worth up to $2,500. Leverage ratios outside of the U.S. can go much higher, such as 400:1.
Forex leverage calculation is as simple as multiplying the numbers represented in that ratio.
For example, if your allowed leverage is 100:1 and you deposit $1,000 of your own money into your account, you will have the opportunity to buy positions worth up to $100,000. You get this figure by multiplying the amount of money you are investing, $1,000, by the 100 represented in your leverage ratio.
You don't have to use the full amount of leverage offered for your account. If you want to leverage a smaller percentage and risk more of your own money when buying a position, most systems will allow you to make that decision.
Currency values make small changes over time, and they never crash to zero or skyrocket to drastically high levels overnight. Those are the volatile movements often seen on the U.S. stock market, but currencies are based on economic systems and large governments rather than smaller businesses. This means that a Forex trader is more likely to collect profits in pennies rather than larger increases.
When you invest a small amount of money on the Forex market, you will receive small returns on your investment even when the market turns in your favor.
For example, if you only have enough cash in your account to purchase 500 euros at a rate of $1.30, you will gain only $5 if you sell those euros for $1.31. You profited a penny for each of your euros, but your profit was small due to the limited number of euros you had to sell in the end.
Leveraged accounts are used to increase the amount of profit you can gain on the Forex market without increasing the amount of money you must invest upfront. This benefits traders with limited funds in the beginning of their Forex career, but seasoned traders use leverage as well.
In simple terms, Forex margin is the amount of equity you need to maintain in your trading account when trading with leverage. This is security for your broker because it ensures that you have the ability to cover losses if the market turns against you on some leveraged positions.
In order to determine how much you can invest in a leveraged trade, you need to understand the margin for your account and consider the amount of cash you can afford to risk in the deal. The more you can invest of your own money, the more you can afford to invest with added leverage.
You can learn more about margin and how it is calculated on this site. You will also need a thorough understanding of the Forex pip before starting to trade on the Forex market.