What is Leverage in Forex?

What is Leverage in Forex?

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A large reason why retail traders choose forex trading over other financial products is that you can often obtain larger leverage with forex than you can with equities.

The simple definition and explanation of leverage in forex trading refer to the process involved with borrowing money from the forex broker. This means that traders can open larger positions because the initial margin requirement is lowered significantly.

Leverage is a prevalent idea in forex trading. By borrowing money from a broker, investors may trade large positions in a currency. Therefore, leverage multiplies the profits generated by favourable currency exchange rate fluctuations.

 

How Does Leverage Work in Forex Trading?

The FX market is the world's largest, with daily transactions totalling more than $6 trillion. Forex trading is buying and selling currencies in the hope that the exchange rate will move to the trader's advantage.

Forex exchange rates are provided or displayed by the broker as bid and ask prices. When an investor wishes to go long or purchase a currency, the ask price is quoted; when the investor wishes to sell the currency, the bid price is given.

Investors use leverage to make more money when they trade currencies. The forex market gives investors one of the highest levels of leverage they can get. There is nothing more complicated about leverage than a loan from a broker to a person who wants to make money.

A forex account is set up for the trader so that they can trade on margin or with money that has been loaned to them. Some brokers may limit the amount of leverage that new traders can use at first.

As a rule, traders can change the amount or size of the deal to meet their needs for leverage. However, the broker will ask that a certain amount of the trade's value be kept in cash in the account, which is called the initial margin.

 

What are the Benefits of Leverage in Forex Trading?

  1. Increased profits
  2. Increased trading opportunities
  3. Shorting the market

1. Increased Profit: The same amount of money you would make in a normal trade can be made with only a small deposit. Profits are calculated by considering the full value of your position, so margins can help you make more money on good trades and lose more money on bad ones.

 

2. Trading opportunities: With leverage, you can get more money that you can use to invest in other things. “Gearing” is the ability to boost the amount of money that can be invested.

 

3. Shorting the market: A way to profit from market movements is to go short. This is when you use leveraged products to make bets on how the markets will move.

 

4. 24-hour trading per day: Some markets are open 24 hours a day. These markets, such as the major indices and foreign currencies, are open all the time.

 

What are the Risks of Leverage in Forex Trading?

  1. Increased loss
  2. There are no privileges for shareholders
  3. There are margin calls
  4. Traders are subject to funding charges

 

1. Increased loss: Margins compound both losses and gains, and because your initial investment is less than in traditional transactions, it is easy to overlook the amount of cash you are putting at risk. 

You may not be able to lose more than your account balance, but you should always assess your trade in terms of its entire worth and negative potential and take the necessary steps to reduce your risk.

 

2. There are no privileges for shareholders: When you use leverage in your trades, you forfeit the benefit of true ownership of the item. For example, using leveraged instruments can influence dividend payouts.

Instead of getting a dividend, the money is added to or withdrawn from your account, depending on whether you are long or short.

 

3. There are margin calls: If your position swings against you, your supplier may request that you put up extra cash to keep your trade open. This is referred to as a margin call, and you will need to either raise cash or sell positions to minimize your overall exposure.

 

4. Traders are subject to funding charges: When you use leverage, you are lending the money to open the whole position at the cost of your deposit. You will be charged a nominal fee to cover the costs of keeping your position open overnight.

What are the Types of Leverage Ratios?

The initial margin requirement will differ between brokers according to the trading volume or the position sizing. The typical margin requirements and leverage ratios that retail traders can expect when they trade forex are as follows.

 

Leverage Ratio Margin Requirement
1:50 2%
1:100 1%
1:200 0.50%
1:400 0.25%

 

What is a Good Leverage Ratio for Forex?

According to practice, the best leverage ratio for forex is between 1:10 and up to a maximum of 1:100.

According to surveys that were conducted by reputable brokers, 40% of retail traders prefer to use leverage up to a maximum of 1:10, while 17% use leverage up to 1:100.

For several trading instruments, European regulations propose that Forex firms restrict the maximum leverage to 1:20 – 1:50. 

Leverage on cryptocurrency exchanges is often set at 1:2 – 1:5. Leverages of up to 1:1000 are chosen by traders who are driven by an emotional desire to boost position volume to the greatest extent feasible without having enough of their own cash in the deposit. 

Traders must take great care when dealing with such forex brokers and ensure that they have solid risk management protocols in place when trading.

How can you Calculate the Leverage Ratio for Forex Trading?

To calculate the real leverage being used, traders can divide the total face value of all open positions by the trading capital as follows:

  • Real Leverage = Total Value of Transaction / Total Trading Capital

For instance, if the trader has a trading account balance of $10,000 and they open a position of $100,000, they will be trading 10 times the amount of capital in the trading account. When traders increase their position size to two standard lots, it means that their open position is worth $200,000 in face value with $10,000 in the trading account, which means that leverage is 20 times.

Other ways to calculate leverage and margin include:

  • Margin = 1/Leverage, for example, a leverage ratio of 1:50 yields a margin percentage of 1/50, which is equal to 0.02% or 2%, while a 1:10 ratio is 1/10 and thus 0.1% or 10%.
  • Leverage = 1/Margin = 100/Margin Percentage, for example, on a margin of 0.02, the margin percentage is 2% with leverage = 1/0.02 = 100/2 = 50 or 1:50.

What are the Best High Leverage Brokers for Forex?

  1. CMC Markets
  2. FBS
  3. Alpari
  4. RoboForex
  5. FreshForex

 

1. CMC Markets: CMC Markets, founded in 1989, provides over 10,000 trading products on sophisticated and diverse trading platforms. They also offer in-depth analyses, trading tools, and instructional resources.

CMC Markets claims to be the single execution venue for all its clients' orders. The broker further confirms that it does not maintain an order book in which clients' orders might offer or take liquidity. All orders are processed at the best available prices and at the fastest possible times.

CMC Markets offers its clients the benefit that they can use leverage ratios of up to 1:500 on major forex currencies.

 

PROS CONS
Well-regulated and trusted broker No United States clients
Keeps client funds in segregated bank accounts with top-tier financial institutions CMC Markets does not offer fixed spreads
Offers powerful trading platforms There are no copy trading platforms offered or managed account options
Provides advanced trading tools
Offers competitive trading conditions and a high maximum leverage ratio

 

2. FBS: FBS is a registered brokerage that offers online trading on a variety of Forex and CFD products across several asset classes. The broker offers traders competitive trading circumstances, such as narrow spreads, cheap fees, and quick transaction execution.

 

PROS CONS
Offers ultra-low minimum deposit requirements No US, Japan, Israel, or Canadian clients
Offers extremely high maximum leverage ratios up to 1:3000 The spreads on the Cent account are extremely high
Offers a choice between different retail investor accounts Inactivity fees are charged on dormant accounts
Provides social trading opportunities
Provides demo accounts 

 

3. Alpari: Alpari is a well-known broker with a global clientele, a variety of adaptable trading platforms, investor accounts, and trading tools. However, regulatory oversight might be increased, as could the range of trading instruments available, which is restricted in comparison to other online brokers.

 

PROS CONS
Offers high maximum leverage up to 1:1000 Lack of comprehensive educational material
Provides investor protection Fixed spreads are not offered
Signals are derived from AutoChartist A limited selection of financial instruments is offered
News is streamed from FxWirePro
Multilingual customer support provided

 

4. RoboForex: RoboForex is a multi-award-winning online broker that provides over 9,400 trading products across numerous asset classes. They provide a variety of trading platforms and accounts, as well as trading tools and in-depth market analyses. RoboForex is well-known for offering some of the highest leverage in the market up to 1:1000.

 

PROS CONS
Keeps client funds in segregated accounts with top-tier financial institutions No US clients
Offers a wide range of financial markets Restricted maximum leverage for EU clients
Provides flexible account types Fixed spreads are not offered
Offers access to a comprehensive analytics centre

 

5. FreshForex

FreshForex is a reputable and well-established STP/ECN broker that offers Forex and CFD trading online using the popular MetaTrader platforms. The brokerage employs ‘Smart Bridge' technology and provides clients with trading recommendations as well as daily market research.

FreshForex is well-known for offering high maximum leverage ratios to traders from around the world of up to 1:3000.

 

PROS CONS
Offers both fixed and variable spreads Spreads are marked up to include the broker fees
There is no minimum deposit requirement Limited range of tradable markets
Trading signals and daily market analysis is available
Offers VPS to eligible clients
There are several flexible account types to choose from 

 

When should you start using Leverage in Forex Trading?

When a trader has a clear edge, they can use leverage. The potential loss of capital may be determined if the level of risk in terms of pips is recognized. As a matter of thumb, this loss should never exceed 3% of trading capital.

Traders can apply leverage in the following financial markets:

  • Shares
  • Indices
  • Forex
  • Cryptocurrencies
  • Precious Metals
  • Energies
  • Commodities, and others

Leverage's most evident danger is that it magnifies losses. Because of financial leverage on solvency, a firm that loans too much money may suffer bankruptcy during a commercial slump, but a company that borrows less money may escape insolvency due to increased liquidity.

Traders must ensure that they are familiar with risk management protocols when they use leverage to trade in financial markets. Traders must use the following:

  • If a price goes against you, attaching a stop loss to your trade helps limit your losses. However, markets change rapidly, and some factors may cause your stop to fail to activate at the price that you have specified.
  • These operate similarly to basic stops but will always be filled precisely to the quantity specified, regardless of gapping or slippage. If your stop is triggered, you will be charged a modest premium in addition to standard transaction fees.
  • Ensure that your retail investor account has negative balance protection. This will ensure that you cannot lose more capital than the balance of your account. If the account balance falls below zero, it is reset at no additional cost by the forex broker.

Is Leverage a suitable tool for Beginners?

Yes, leverage can be a suitable tool for beginners.

Many newcomers are drawn to leveraged earning strategies because they desire to generate more money in a shorter amount of time. However, traders must remember that leveraged trading carries a certain degree of risk. To use leverage, beginners must have a clear understanding of the following concepts:

  • Balance and Equity of the trading account
  • Margin
  • Free margin
  • Account Level
  • Margin Call
  • Stop Out

If traders are new to Forex, a 1:10 leverage and a USD 10,000 balance would be a good place to start. As a result, the ideal leverage for a newbie is unquestionably not greater than a 1 to 10 ratio.

What Should Be Considered When Using Leverage?

  1. The Risks Involved
  2. Traders must try to maintain the lowest level of leverage
  3. Use trailing stops
  4. Traders must limit their capital for a single trade

 

1. The Risks Involved: The use of leverage comes with the potential to earn more profits, and this is equal to the potential to incur great losses if the market turns against the trader. Traders must always consider the risks involved with using leverage in terms of their position size, negative balance protection, exchange rates, trading strategies, and several other components.

 

2. Traders must try to maintain the lowest level of leverage: Traders must only use the amount of leverage necessary to increase their profit margin without risking more than they can afford to lose.

 

3. Use trailing stops: Traders must use trailing or limit stops to ensure that they can reduce their losses if the market turns against them. Limit stops allow investors to continue learning how to trade currencies while limiting losses if a deal fails. 

These stops are also significant since they help to eliminate trading emotion and allow individuals to walk away from their trading workstations without emotion.

 

4. Traders must limit their capital for a single trade: Traders must not risk more than 1% or 2% of their total trading capital per position that they open. This means that they effectively use a risk-reward ratio of 1:1 up to 1:2.

 

Which other forex terms relate to Leverage?

Simply explained, the margin is the amount of money needed to initiate a trade, whereas leverage is the multiple of account equity exposure. The amount of margin required is determined by the margin rate regulations. 

This varies based on market volatility and liquidity in the underlying market for each trading instrument. In forex trading, leverage is closely associated with the overall forex margin rate, which indicates what percentage of the total transaction value is required to enter the deal. 

While forex brokers offer a live trading account where there is no minimum deposit requirement, traders must ensure that they deposit enough funds to cover the margin requirement to open a trade.