Usually leverage is quoted as a ratio that is 100.1
It means that you can trade with 100 units by just investing 1 unit. By just investing 1,000 USD you can trade up to 100,000 USD
Margin is quite same as leverage, but a view point is little different. Margin is usually quoted as a percentage that is 10%
Borrowed money trading is leverage. Brokers in the foreign exchange provides greater leverage than the brokers in the equities and future market, that makes forex more tempting and interesting than other kinds of traders. It is important to understand that the leverage is not without any flaw. It has the potential to notably rise trader’s earnings, but it can also substantially increase their losses, if incorrectly applied.
Leverage and Margin
Leverage will also specify margin conditions that is the amount of currency that the trader should have in their account. For example,
some brokers offer a maximum of 20:1 leverage that is for every 20 units of currency the trader purchase, they must have a 1 unit in their account. There are brokers who offer up to 100.1 leverage, there are few who even give a leverage of up to 400:1
Since traders who are trading with leverage, because they use borrowed money there is a possibility that they might lose greater money than they have in their account. In order to stay away from this situation, most of the forex traders design a system known as an automated margin call. Automated margin call make good use of the system when the worth of the trader’s account is lower than the margin requirements, when the condition is as such then the majority of the forex brokers will quickly and automatically close the trader out of their position, that is how they avoid end up in negative account balance.
In order to understand its working, there is a following example
If a trader buys 100,000 EURUSD. The margin required is $ 1,000 per $ 100,000 units traded. Assume that only $5000 in the account of trader. In such a situation, each pip is worth $10. if against the trader EURUSD goes 401 pips, the trader will have a floating loss of -4.010 US dollars (401 pips* 10 USD per pip) As the trader has an opening balance of $5000, then their variable value of account will be $990 – the variable loss of $4010 = 990. As its below the required margin, which the broker has agreed upon. As a consequence the broker is free to close the position as he desire – without consulting the trader.
Leverage Facilitate Greater Control of Risk
Although leverage is considered to be a risky business but it can be a valuable tool to monitor risk and vulnerability they are exposed to. For example leverage is used by many traders as assets that are comparatively predictable. It makes leverage that can be well organized and controlled, having primary source of risk – as against the asset’s instability that cannot be regulated by the trader. Such thinking is popular amongst forex traders when the trend of currency movement is in a very narrow range, as compared to stocks and futures, a 2% shift in price in a day is amazing for a currency, but is normal in most of the equities markets. Resulting in forex traders to use leverage to trade predictable currencies and enjoy greater power and take their chances freely. They depend on the leverage ratio that they have selected than the basic asset’s instability.
Traders should be careful in using leverage. It enhances their earnings immensely and is popular amongst dynamic forex traders – but its also responsible for great loss especially those who are new to the market
A simple example:
- If I have 1000 USD I can invest in forex trading, my choice fo broker is the one who gives me a leverage of 1:200. so that I can buy 200 dollars from my 1 dollar or I USD is equal to 200 USD
- I will trade and decide how much I want to invest and how much I will use as a reserve. If I want to trade with 100 USD, it means investing 20,000 USD
On every pip I will acquire 2 USD gain or loss. If 1,5677 USD/GPB is a trade buy. After 10 min its 1,5699. it means 20 pip profit, my gain is 40 dollars. If the market is 1,5655 then I incur loss of 40 dollars
In leverage you have an equal chances for success as well as failure. If you want to use leverage be careful before you take your chances. In leverage a trader might begin with as little as zero and soon become a millionaire or begin from a millionaire and soon become zero