A Guide to Leverage in Forex

Leverage in forex is a technique that allows traders to ‘borrow’ funds to gain greater exposure to the forex market with a relatively small initial deposit.

One of the reasons so many people are attracted to trading forex compared to other financial instruments is that you can usually get much higher leverage with forex than you would with stocks for instance.

However, leverage in trading can be a double-edged sword as it can magnify both profits and losses.

What is leverage in forex?

Leverage in forex is a way for traders to borrow capital to gain a larger exposure to the forex market. Basically, with a limited amount of capital, they can control a larger trade size. This can lead to bigger profits and losses as they are based on the full value of the position.

Trading with leverage, which is also referred to as margin, means you can magnify profits if markets move in your favour. However, you can also lose all your capital if markets move against you. This is due to the fact that profits and losses are based on the full value of the trade, and not just the deposit amount.

Leverage and margin

Margin is the amount of money you need to open a leveraged trade. When trading forex on margin, you only need to pay a percentage of the full value of the position, which acts as a deposit. Margin requirements may differ between brokers, but start at around 3.3% for the most traded currency pairs, such as EUR/USD, USD/JPY and GBP/USD.

Advantages of using leverage

One of the main advantages of leveraged trading is that it provides you with access to additional funds because you are borrowing money from the broker to gain more exposure to the market.

You are exposed to a larger position in the market, so you have the opportunity to magnify your returns. However, leveraged trading can also magnify your losses.

Risks of using leverage

Just as leverage can magnify your returns, it can also magnify your losses.

For this reason, having an effective risk-management strategy in place is essential for using leverage in forex. High leverage forex brokers usually provide key risk management tools which can help traders to manage their risk more effectively.

Managing risk

Stop-loss orders

A stop-loss order is used to limit your losses in an unfavourable market by closing you out of a trade that moves against you. You are basically specifying the amount ou are willing to risk on the trade. However, even if you lace a stop-loss the close out price cannot be guaranteed due to slippage.

A trailing stop-loss works in a similar way to a regular stop- loss. However, when the market moves in your favour, the trailing stop-loss moves with it in order to secure any favourable movement in price.

A guaranteed stop-loss order will be executed at the specific price you want, regardless of market volatility or gapping.

Take-profit order

A take-profit order works in the same way as a limit order as it is always executed at the price you have specified. Where the market for any asset opens at a more favourable price than your target price, your order will be executed at the better level.

Summary

Margin is the deposit amount required to open a trade, whereas leverage is capital borrowed from the broker in order to gain exposure to larger trading positions. Therefore, forex trading on margin allows traders to open larger positions with relatively small deposits. Just remember that trading on leverage can be risky as losses, as well as profits, are magnified.

DISCLAIMER: This information is not considered as investment advice or an investment recommendation, but is instead a marketing communication