What is Forex Leverage and How does it Works? 2021 Guide


Advertising Disclosure This article/post contains references to products or services from one or more of our advertisers or partners. We may receive compensation when you click on links to those products or services

In foreign exchange currency trading, sometimes called forex or abbreviated as FX, leverage is a way to gain more extensive market exposure with a relatively small market position. Using forex leverage, you could see a $1,000 investment give you the equivalent of buying $2,000, $3,000 or more of the foreign currency. Here’s a guide to forex leverage and what you need to know when getting started with this risky financial product.

What Is Leverage in Forex?

In forex, leverage is a term for trading with more funds than are available in your account. In a leveraged trade, you can get many times the market exposure as you could with the funds you’ve deposited in your account.

Some brokers and traders require just a 1% margin, which means you can effectively get 100x leverage on the transaction. If you have $1,000 in your account and go all-in on euros with a 1% margin requirement, you’re trading with the equivalent of $100,000 of euros. You will experience gains and losses as if you had invested $100,000 even though you only have the $1,000 in your account.

Depending on the brokerage, your account history, and the currency pair you choose, it’s not unheard of to trade with 100x leverage in forex.

How Leverage Works in Trading

To better understand how leverage works in forex trading, here’s a step-by-step example:

Let’s say you want to trade the USD/CAD currency pair and have $5,000 in your account. You want to commit $1,000 of your balance to trade with a 2% margin requirement. That means 2% of your trade comes from the $1,000, and the remaining 98% comes from the broker. Your $1,000 gives you exposure to $50,000 in CAD.

If CAD goes up by 1%, your profit is $50,000 x 1%, or $500. That’s a lot more than the $10 you would have earned trading just the $1,000. However, if CAD goes down by 1%, you would lose $500. That’s a 50% loss on your $1,000 investment. With leverage, the good and the bad are amplified in your trading account.

Brokers With High Leverage

While some forex brokers will let you trade at 100x leverage, not all are so generous. To limit their own risk, many brokers maintain lower margin requirements and offer less leverage.

For U.S. traders, you may not find the extremely high leverage available to those outside of the States. That’s partially due to trader protections imposed by the SEC and CFTC, among other regulators and agencies. Forex.com offers those in the United States 1:200, which is one of the higher leverage options around.

Here are some of our top recommended forex brokers:

E*TRADE

E*TRADE allows you to borrow up to 50% of your eligible equity to buy additional securities. E*TRADE supports forex trading through forex options and futures. Etrade Margin

TD Ameritrade

TD Ameritrade features a 23 hour per day forex trading platform that runs six days a week.  TD Ameritrade accounts with at least $125,000 invested can buy up to 6.7x more than the typical margin account. TD Ameritrade margin

Ally Invest

Ally Invest operates a 24/5 forex market. Ally Invest allows margin and leverage in its forex platform.

Check out our complete guide to forex and forex brokers to learn more and pick the best forex app for your needs.

How to Best Use Leverage in Forex

For the typical investor, it’s best to avoid leverage altogether. As you can see in the example above, a 1% move in currency prices could cost you 50% of your account balance. If you’re an experienced, expert, confident trader, you may want to take advantage of leverage to amplify your trading profits.

Because many traders lose money, however, it’s best not to use leverage at all. Stick with the account balance you can afford so you can enjoy your trading experience without amplifying potential losses.

What Are the Risks of Forex Leverage?

When reading about forex, you come across the word risk time and again. That’s for a very good reason: forex trading is risky. When you pile on the added risks of leverage, forex trading becomes extremely risky.

Most people should avoid trading in the forex markets due to risk. If you are among those who feel comfortable trading currencies, then you should think carefully about using leverage. Leverage is highly risky and makes it possible to lose more than your account balance.

What Are the Benefits of Forex Leverage?

The benefits of forex leverage are improved profits when you make a good trade. Again referencing the example above, you could make 50% on your account balance with just a 1% increase in forex prices when you trade with a 2% margin requirement. If you can trade a currency pair at a 1% requirement, you can double your money with a 1% change in asset prices.

This type of leverage can lead to much faster and more significant returns than traditional investments like index funds. But again, the added risks make it a less ideal way to trade or invest for most people.

Is Forex Leverage for You?

If you didn’t pick it up from the warnings above, most people should not trade forex using leverage. The risks are simply too great for the potential return. If you do trade forex using leverage, you should go in eyes wide open, just like a roulette table or blackjack table where you can double your money or lose it all in the blink of an eye.

If you decide to trade forex with leverage, proceed with caution and fully understand your market exposure and risk. It would be a shame to wind up in debt from a fun hobby like forex.



Source link

Leave a Reply

Your email address will not be published. Required fields are marked *