In this article I will talk about leverage and margin in forex trading. These are very important concepts, but at the same time they are a bit complicated for beginners, so I will focus on the basic information.
Forex Leverage and Margin
Leverage basically means how much bigger you can open trades in relation to the size of your account.
You might think that your broker is lending you money, but that’s not quite the case.
Let’s look at an example:
Let’s say you deposit €10,000 into your account and your broker offers you a leverage of 1:50.
This means that your broker will allow you to trade up to €500,000 because it offers you a leverage of 1:50.
Your broker will not physically or electronically lend you €490,000 to your account. It only means that you can trade up to €500,000.
If you switch brokers and they offer you 1:100 leverage, you can trade up to €1,000,000.
Just take the leverage factor and multiply it by the amount of money in your trading account.
So what is margin?
Basically, margin and leverage are two sides of the same coin.
Margin in forex trading is the amount of money you need to have in your trading account to open a position. Let’s say it is a minimum deposit required to cover the losses you may incur on a trade.
In the above example, we are talking about a leverage of 1:50, which means that your margin here is 2%.
This means that your broker must deposit at least 2% margin into your account in order for you to trade at your desired 1:50 size.
To simplify: If you open a trade worth €100,000, your broker will require you to deposit 2% of this amount into your account, which in this case would be €2,000.
In summary, in forex trading, the use of leverage allows you to trade with larger amounts than you have in your account, but leaving a deposit to cover any losses.
Leverage: a double-edged sword
With higher leverage, you can potentially make more money.
But at the same time, you can also lose more money in a shorter period of time, because all it takes is a small percentage deviation to your disadvantage to significantly increase your losses.
And depending on how much leverage you use, you can lose a lot.
Therefore, you should not really think about leverage and margin when you open trades with large amounts of money.
You simply set the stop loss, and from there you calculate the appropriate position size for the trade. In other words, you calculate your risk and know in advance how much you are willing to lose.
So it is not used to open huge positions, but it is a tool to use our capital intelligently.