What is leverage in trading?
You are not the first to ask what is leverage in forex trading, and you will certainly not be the last! Leverage is such a key concept in forex trading, and refers to the ability to control a large amount of currency with a relatively small amount of capital. This enables traders to enter into larger positions than they would be able to without leverage.
Forex trading is typically done on margin, which means that traders are only required to put up a small percentage of the total trade value. The rest is provided by the broker, at a ratio known as the leverage ratio. For example, if the leverage ratio is 100:1, this means that for every $1 that you have in your account, you can trade up to $100 worth of currency.
While leverage can magnify profits, it also magnifies losses. Leverage is usually found in complex financial instruments and comes with a high risk of losing money. You should always consider whether you understand how leverage or CFDs work, and whether you can afford to take the risk before you begin to trade with leveraged products.
Forex leverage by Country and trade size
The foreign exchange market is the most liquid globally, and also uses leverage very readily. When trading on a margin account, you will need to keep a close eye on the leverage ratios of the different financial markets as many instruments have different maximum leverage levels, and different regions and financial regulators will also put in place varying restrictions.
Trading With Leverage In Europe
For example in Europe, ESMA have implement a standard maximum leverage amount that is allowed for any retail investor accounts which top out at 1:30 for major forex pairs.
Trading leveraged equities for in Europe has a restriction o f 1:5, whilst leveraged cryptocurrency trading is capped at 1:2. It needs to be noted that leveraged trading of cryptocurrencies is not allowed at all by the FCA in the UK.
The exemption to the rule above is for those with considerable experience trading with leverage who can be classified as professional traders, albeit at the expense of their underlying protections. This is not the route you should try to go down if you are at all new to trading accounts.
Leveraged Trading In Middle East, Asia, and Australia
In the Middle East, the majority of the regulators cap leverage at 1:50 for locally regulated firms, and in Australia, ASIC have largely very similar ratios to that of Europe across the varying instruments.
With certain other Countries such as Malaysia leverage is a little bit of a question mark, meaning the local regulator LFSA has imposed a rule of 1:100 leverage as a maximum but the brokers who are not locally regulated do not need to abide by some of the same policies.
This is the same across other Countries also including South Africa, Nigeria, Indonesia, Thailand, Vietnam, and many others where many International online forex brokers operate without local offices.
High Leverage Forex Brokers Usually In ‘Third’ Countries
Where is starts to get a little unnerving with leveraged trading accounts is in third Country jurisdictions, or offshore regulators. Some of these high leverage brokers offer trading leverage of 1:500, or even 1:1000.
Technically, many brokers that have these third Country regulators also have other Tier 1 regulators with these lower levels of allowed leveraged trading but they can provide the option for users to choose which branch they open their account with.
Even though the ‘brand’ of the brokerage account or trading platform is the same, the regulator and the underlying company this is registered to is different. It is an operational difference, but one that forex traders should be aware of as it does impact your rights as far as your regulatory protection.
Position Size For 1 Lot When Trading With Leverage In Forex Markets
A 1:100 leverage ratio means that you must be responsible for a ratio of 100 times the value of your committed capital amount.
Standard trading lots involve 100,000 of any currency, so in an underlying trade of this magnitude you would need a capital amount of 100,000/100 which equals $1000.
There are many brokers now that offer mini and micro lot accounts that allow you to make trades at 1/100th of those levels.
The margin requirement for each broker may also differ between large and smaller transactions. Most brokers give investors the chance to do small trades with margins a little lower. The first account is likely not qualified to gain 1:200 leverage and likely nor would you want it to.
How To Calculate Leverage In Forex
It is important to know how to calculate leverage in forex, even if the trading platform does it for you! This forex leverage calculator can determine how much money is needed and help manage trades and give you a better idea of your margin requirements. With a goal once trading for real being to avoid margin calls, calculating the optimal size of positions you open is important to achieving this.
The forex leverage formula calculation is : L = A/ E
L is leverage, E is margin amount and A is assets value. You can start out using the margin amount using the leverage ratio to determine positions’ dimensions. A = TL. Therefore multiply the margin by the leverage ratio to get the market capital.
Different types of leveraged Trading products
The most leveraged trading involves derivative trading which translates to trading instruments which take their value to the prices of the underlying asset rather than owning it. Most leveraged trading services are offering CFD contracts outside of the US, but not all.
A CFD is essentially an agreement between providers to trade the difference in the market value of certain financial products between opening and closing. Visit spread betting vs CFDs and find out what makes them different. Many other leveraged product options are also available, including futures, options, stocks, and some ETFs. Though each can operate differently, using leverage brings an ability to enhance both profits and losses.
Leveraged equities
Leveraged equities are products that allow you to trade with leverage on stocks or other equity instruments. For example, you might be able to trade with 1:5 leverage, which means that for every $1 you have in your account, you can trade as if you had $5 and amplify positions but also the way in which they are traded is different.
With leveraged equities, you will likely find you pay a ‘spread’ to the broker as opposed to a single transaction fee as you would with DMA or direct market access. There are some brokers that are ‘hybrid’, in offering both leveraged and DMA equities which will give you some good insight into the variance.
Trading CFDs With Leverage
These are contracts for difference that allow traders to trade on the price movements of assets, without actually owning the underlying asset.
CFDs are leveraged products, meaning that CFD traders can open a position with a smaller amount of capital than would be required if you were trading the underlying asset directly. It is also an easier way to access markets such as commodities and options, and also other areas where you do not want to get into asset ownership tax.
Whilst you should always check with your own local tax specialist the treatment of this type of derivative in your Country, in most cases these are taxed as income on profits as opposed to having stamp duty added as in the case of direct stocks or asset purchases.
Leveraged ETFs
These are exchange traded funds that use leverage to provide investors with exposure to an underlying index or asset. Leveraged ETFs are typically used by investors who want to gain exposure to an asset without actually buying it.
ETFs are a good way of gaining access to a specific industry segment but without having to be a specific stock picker. An ethical investing ETF for example as opposed to picking out 1 or 2 individual companies is a considerably easier way for the novice investor to minimise risk.
Trading With Leverage – What is a good leverage?
Many people ask themselves this question when they are first starting out in the world of online trading. The answer, unfortunately, is not a simple one. It depends on a variety of factors, including your level of experience, your risk tolerance, and your investment goals.
That being said, there are a few general guidelines that can help you determine what is a good leverage for you. If you are new to online trading, it is generally advisable to start with a lower leverage. This will help you minimize your risk and give you time to learn the ropes before taking on more substantial risks.
As you become more experienced, you may want to increase your leverage. This can help you maximize your profits potential. However, it is important to remember that with increased leverage comes increased risk. So, you need to be sure that you are comfortable with the risks before increasing your leverage.
Starting Out With Leveraged Trading Should Be On Demo
With your first leverage trading account, you will want that to be a demo or paper trading account while you get to know some additional key terms and understand how market moves can see you losing money rapidly due to leverage. Do not fight it in a demo account, actively see how a margin call in leveraged trading can sneak up on you rather quickly.
Forex brokers will give you a margin trading account within a matter of minutes to get testing your investment strategy before you deposit real funds. You should embrace the fact that you live in an age where this is possible as this is a rather new additional for retail investor accounts. All successful forex traders have experienced a margin call in the forex market, it is what happens when your leverage ratios are slightly overextended.
Learn Leveraged Trading Whilst You Practice
The goal of your demo account at least initially should be to see how stock market leverage, foreign currencies, and trading CFDs need proper risk management strategies in order to be successful. Your trading position, and your buying power is massively increased with leverage trading but that can be a double edged sword without risk management tools having been properly configured.
Know your margin requirements, understand the risk involved and really understand how leverage works before you use it in your CFD trading, or other instruments.
The forex market whilst being one of the most potentially profitable for trading, is also fraught with those that do not manage risk management tools well enough and unfortunately blow up their accounts. If we can save you from that fate by rambling about demo accounts and practicing your trading as much as possible, then it will be time well spent.
When You Move Onto A Real Account, Keep Your Forex Leverage Tight
When you do actually reach the point of being ready to deposit additional funds, as a beginner, it may be helpful to limit the leverage to 1:10 during the earlier phases even if the broker allows you to use more.
Many involved in forex trading often make an early mistake of seeing success and then amplifying up leverage, using high leverage brokers and risk ratios. This piece started off by asking what is leverage in forex, and although it is not the official answer, it is safe to say that leverage is something that can make or break you in trading.
We highly recommend trading at a very low leverage until you have a really solid understand of the behaviour of the instrument you trade most and remember that one of the biggest parts of being a successful trader is keeping yourself and your balance ‘in the game’.
The profits will come if you are in the market long enough, and you will be in the market longer if you control your margin usage.
Trading With Leverage FAQs
What is leverage in trading?
Leverage is the ratio of borrowed money to your own money in a trade. For example, if you’re trading with a leverage of 1:100, that means you’re borrowing $100 for every $1 that you have invested of your own capital.
Why use leverage in trading?
Leverage allows you to open larger positions than you could with your own capital alone. This can help you increase your potential profits – but it also comes with increased risk.
How do I calculate leverage?
You can use a leverage calculator to work out the leverage you’re using on a trade. To do this, you’ll need to know the size of your position and the margin requirement for your account.
What is margin in trading?
Margin is the amount of money you need to open a position. It’s usually a percentage of the total trade value. For example, if you’re trading with a 1% margin, that means you only need to put down 1% of the total trade value to open a position.