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What is Leverage and Margin in Forex trading?


What is leverage and margin in Forex trading?

Traditional stockbrokers in the United States often offer margin trading to their clients. The broker will lend money to the client for additional stock purchases and then earn interest on repayment of the loan. Margin rates vary, but most online brokers charge clients between 5% and 9% for borrowing depending on the amount. Why would clients want to borrow money for the stock market from their brokers?

They want to crank up the leverage on the trades.

Leverage refers to how much borrowed money is involved in a trade. At most stock brokerages, investors can receive 2:1 leverage, which means they need $50 in their account to trade $100 in capital. Obviously, leverage adds risk to any trade. Since you don't lose your capital, if it goes bad, you pay your broker money.

Excessive leverage has killed many financial firms, including Lehman Brothers and Long Term Capital Management. But when used properly, you can make tremendous profits with little upfront capital.

In Forex trading, leverage can often be as high as 500:1. Since currencies move more incrementally than stocks, using leverage does not carry the same risk. When trades are measured in fractions of a penny, the 500:1 leverage does not seem excessive. Forex brokers use margin requirements to determine how much profit a currency trader can make per trade. It is expressed as a percentage, such as USD/EUR trades that require a 2% margin.


Difference between leverage and margin in forex

Another concept that is important to understand is the difference between forex margin and leverage. Forex margin and leverage are related, but they have different meanings. We have already discussed what is Forex margin.

This is the deposit required to place a trade and keep a position open. Leverage, on the other hand, enables you to trade sizable trade sizes with smaller capital outlays.

A leverage ratio of 30:1 means that a trader can control a trade worth 30 times their initial investment. If a trader has $5,000 available to open a trade, they can effectively control a position with a total value of $150,000 when the leverage ratio is 30:1.

In Forex trading, leverage is related to the Forex margin rate which tells a trader what percentage of the total trade value is required to enter a trade. Therefore, if the Forex margin is 3.3%, the leverage available from the broker is 30:1. If the Forex margin is 5%, the leverage available from the broker is 20:1. A Forex margin of 10% equates to a leverage of 10:1.

In the forex market, currency movements are measured in pips (percentage in points). A pip is the smallest movement a currency can make. For most major currency pairs, such as GBP/USD, one pip is a price movement of 0.0001. If GBP/USD moves from 1.4100 to 1.4200, that's a movement of 100 pips, which is only a one percent move in the exchange rate. While the move of one cent may not seem like much, with the use of leverage, it can generate a significant profit for a forex trader.

That's why leverage is important in the forex market, as it allows small price movements to be translated into large profits. However, at the same time, leverage can also result in large losses. Therefore, it is important that leverage is managed properly and not overused. Leverage increases risk, and should be used with caution.

Leveraged trading is a feature of financial derivatives trading, such as spread betting and CFD trading. Leverage can also be used to take positions in a range of asset classes other than forex, including stocks, indices and commodities.


3 Things to Consider for High Leverage Trading

Here are some important points to consider in forex trading or any type of trading with high leverage:

Margin calls can be a common occurrence: Especially at the small money level, even a small change in the price of your asset can trigger a margin call. This is where you do not have enough money accumulated to cover the losses from leveraged trading. The broker may request you to make an additional deposit otherwise your position may be closed automatically.

The higher the leverage here, the more sensitive you are to price changes. It is worth remembering that at 1:100 leverage, even a change of only $0.10 in forex value equals $10 depending on your leverage.


Volatility increases the risk of trading with high leverage : As mentioned, even small changes in the price of an asset can add up very quickly when operating with high leverage. Market volatility has the potential to drain your account very quickly in some cases, so it is worth investing in more stable assets and making sure to set regular stop losses.


Risk management is important: Overall, it is clear that leverage is high risk. This risk only increases when leverage increases. Even professional funds and traders can be wiped out by a volatile market that triggers a margin call. For this reason it is essential to determine your risk management tools, stop loss and take profit levels. Using a demo account is also a very wise move to learn more about trading before risking real money.


United States Limitations

Forex trading is subject to stricter regulations in the United States than in most countries in the world. Europe and Australia have no opposition to leverage as high as 500:1, but US law limits Forex brokers to 50:1 leverage.

Additionally, many Forex brokers offer contracts for difference (CFDs) on indices, bonds, commodities and even cryptocurrencies. These products are highly speculative and are completely sold in the U.S. which means that MetaTrader 5 has practically no uptake

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