Forex Leverage Basic ExampleWhat is Forex Leverage?

Leverage is the practice of investing a small amount of something in order to control a larger share of something else.

That may sound complicated, but if you have ever had a credit card, you are already familiar with the basic concept. When you apply for a credit card, you leverage your credit history, your reputation, in order to gain access to funds that you can use to purchase goods and services.

When you make charges to the card, you are using money that you technically don't have in your account. The creditor covers the purchase because they have checked your credit and trust you to pay back the money charged plus interest.

Understanding Forex Leverage

In the Forex market, you have to leverage a small amount of money in order to make trades for a larger sum of money. You start the process by applying for a margin trading account in the same manner that you might apply for a credit card. Before selecting a broker to handle this account, you should read reviews to determine two critical pieces of information.

1. Margin.

This is the amount of money you must have in your account prior to trading. It is expressed as a percentage. For example, if your broker trades in 100,000 currency units and the margin is 1%, you will need to deposit 1% of 100,000 into your account prior to making trades. That would make your minimum deposit amount $1,000.

2. Maximum Leverage

Forex leverageThere are three primary options: 50:1, 100:1 and 200:1. When you see 100:1, it means that you need $1 in your account for every $100 traded.

Let's put this together. Imagine you open an account with a brokerage that requires a $1,000 margin and offers leverage of 100:1. You want to buy a position in a currency pair, but you only have the minimum required $1,000 in your account. You have the option of leveraging the trade, investing your $1,000 plus money fronted by your broker.

In order to determine how much you can invest in a leveraged trade, multiply the amount of money you want to contribute to the deal by the first number in the leverage allowed by your broker. In this example, the leverage offered is 100:1 and you have $1,000, so you would multiply 100 by 1,000 to determine that you can invest up to $100,000.

Should You Leverage Trades?

Does it sound risky to place trades worth far more than you actually have funded into your Forex account? It is risky, but this is a way to maximize profits when you firmly believe that a trade will pay off in the end. When you close a trade successfully, the profits will far exceed what you could have earned by investing only the amount of money funded to your account.

If you don't feel comfortable investing leveraged funds knowing that you will need to repay your broker if the market turns against you, then don't do so. It is never a good idea to invest more than you can stand to lose, especially if you are a new trader with limited experience.

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