Investors get attracted to forex rather than stocks because of its higher leverage options. The term ‘leverage’ is very common in the world of financial markets; however, few actually have a clue of what the term really is.
What is ‘Leverage’?
Leverage is all about borrowing a particular amount of money required for investing. In forex’s case, the money is usually on loan from the broker. Trading in forex indeed offers a high leverage in a sense that for a particular margin requirement, a trader can control a large amount of money.
How do you calculate margin-based leverage?
To calculate margin-based leverage, simply divide the value of the total transaction by the margin amount you need to put up.
To illustrate further, if what you need is 1% of your total transaction value, and you intend to trade a lot of USD/CHF equivalent to 100,000 US dollars, then you require 1,000 US dollars. Consequently, your margin-based leverage should be a ratio of 100:1. If your margin requirement is 25%, then by using the same formula, you’ll come up with a margin-based leverage of 400:1.
Take note that the margin-based leverage does not affect the risks. It may not influence the trader’s gains or losses. The investor can choose to attribute higher than the needed margin for a particular position
The more important factor is the real leverage, rather than the margin-based one.
How do you calculate real leverage?
Real leverage is calculated by dividing the open positions’ total face value by the amount of your trading capital.
If you have $10,000 in your trading account, and you open a standard lot equivalent to $100,000 position, then you’ll be trading on your account with 10x leverage. If two standard lots are traded, then the leverage is 20x, and so on and so forth.
Forex Trading Leverage
The currency movements in forex are traded in pips (the smallest currency price change). Depending on the currency pair, it could be in the price’s second or even fourth decimal place.
Hence, transactions should be done in huge amounts to allow the little price movements to be translated into acceptable and decent profits. In forex trading, you are provided with the freedom and flexibility to choose the real leverage amount depending on your trading style, money management preferences and your personality.
Remember the Risk
Your real leverage will have the potential to enlarge your gains and losses and both will have the same magnitude. The larger the amount of leverage, then the higher is your assumed risk.
Your trade can be given more breathing room by using a smaller amount of real leverage on each by implementing a wider but a more reasonable stop to prevent risking your money. A trade that’s highly leveraged can deplete your trading account fast which will lead to greater losses.
Leveraging is flexible and customizable. You don’t have a deadline to meet. Take your time if you aim for a profit.
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