Forex leverage is a tool about which every trader should be well-aware of. Most of the forex investors use this tool to maximize their return on investment in the market. Therefore, traders who would like to maximize their return profit can certainly use this trading tool. However, it involves a certain level of risks where traders may incur a significant amount of loss while trading with leverage.
In-depth knowledge of what is forex leverage
In forex trading business, investors make use of leverage to earn maximum profit from the unstable currency exchange rate of two nations. The amount of leverage the traders gain from this market is high. Many people think that leverage is the amount of loan provided to traders by the brokers who actually manage their accounts.
But this assumption is completely wrong. When any investors agree on a term to make an investment, they establish margin account with the help of a broker to earn profit through leverage.
The leverage amount is set regarding the basic ratios such as 100:1, 200:1, 50:1. However, the ratio is not fixed, and the broker can change the ratio level depending on the investment amount. A regular trading basically takes place in the amount of 100,000 (as per the standard lot) where the forex leverage ratio stands for 100:1 or 50:1. A leverage ratio of 200:1 is ideal for a trade size of $50,000 or less.
How does Forex leverage trading work?
Leverage trading works when you establish a rate for every dollar present in your account. The amount of money you invest for the trade is the actual money you bid on risk. This is called margin or the amount of risk you take up for your trade.
To define in simple terms, let’s cite an example here. Suppose you invest $100, and you set the leverage at a ratio of 100:1. It means you have $100 in your account to trade for every $1 in your margin investment. Therefore, if you start trading with $100, you can buy trade up to the value of $10,000.
What is the role of leverage forex trading?
In the forex market, leverage trading takes place for creating the possibilities of making bigger profits. The use of leverage is imperative for traders as forex trading involves a little difference in prices. The amount of difference can be minuscule as one percent.
With such small amount of investments, it may a long time to make a meaningful profit. Using leverage, you can expect to get a higher return on investment in less possible time even in smaller initial investment. However, it is also suggested traders to gather enough information about this tool before start operation in forex market. The higher the chances of leverage, the more chances will be there of losing investment when currency pair goes in reverse direction to your investment.
Though the use of leverage in higher degree is more vulnerable to risks, still it is a magnificent trading tool that can be used to maximize profit in less possible time in the forex trading market. And to avoid its possible risks, you can use few safety precautions that are used by experienced traders to mitigate the risks associated with leverage.
Hope you enjoyed my article on forex leverage.
The content of this article reflects the author’s opinion and does not necessarily reflect the official position of LiteForex. The material published on this page is provided for informational purposes only and should not be considered as the provision of investment advice for the purposes of Directive 2004/39/EC.