Analysis Of Forex Leverage: A Double-Edged Sword
Forex Leverage: A Double-Edged Sword
In comparison to stocks and other financial instruments, forex provides traders with a big advantage of its higher leverage. However, not all the traders know what “leverage” means and how exactly it works. After reading this short article, you will learn more about it.
What is leverage?
Leverage means borrowing a certain amount of money with an intension to invest it in something after. The money is normally borrowed from a broker, and high leverage in forex trading means that a trader can control a huge amount of money.
In order to calculate margin-based leverage, follow this formula:
Margin-Based Leverage= Total Value of Transaction/Margin Required
For instance, if you have to deposit …show more content…
Whether a trader is required to put up 1 or 2% of the transaction value as margin may not influence his or her profits or losses. This is because the investor can always attribute more than the required margin for any position. And you need to look not at margin-based leverage but at the real leverage. In order to calculate real leverage follow this formula:
Real Leverage= Total Value of Transaction/Total Trading Capital
For instance, if you have 10000 $ in your account, and you open 100000$ position, you will be trading with a 10 times leverage on your account. In case you trade two standard lots, which is worth $200,000 in face value with $10,000 in your account, then your leverage on the account is 20 times (200,000/10,000).
It means also that the margin-based leverage is equal to the maximum real leverage possible to be used by a trader. Usually, traders’ real leverage is different from their margin-based leverage because most of traders do not use their complete accounts as margin of each of their …show more content…
For instance, when a currency pair GBP/USD moves 100 pips from 1.9500 to 1.9600 this is just a one cent move of the exchange rate. Exactly for this reason, currency transactions should be done in big amounts in order to transform these price movements in big profits using the leverage advantage.
If you are involved with such big amount as 100000$ , then even small changes in the price may have big losses or profits.
You have all the freedom and flexibility to select your real leverage amount in trading based on your personality and trading style.
Risk of Excessive Real Leverage
Real leverage has the power to increase your profits or losses by the same amount. So the risk is higher when you apply big amount of leverage on the capital. Be aware that the risk does not have to be directly related to margin-based leverage even though it can have some impact if the trader is not very careful.
We are going to illustrate this point with an example ( See Figure 1).
Trader A and Trader B have a trading capital of US$10000 and both of them trade with a broker that requires a 1 % margin deposit. Then, they agree that USD/JPY is reaching a top and should fall in value. Thus both of them short the USD/JPY at
In comparison to stocks and other financial instruments, forex provides traders with a big advantage of its higher leverage. However, not all the traders know what “leverage” means and how exactly it works. After reading this short article, you will learn more about it.
What is leverage?
Leverage means borrowing a certain amount of money with an intension to invest it in something after. The money is normally borrowed from a broker, and high leverage in forex trading means that a trader can control a huge amount of money.
In order to calculate margin-based leverage, follow this formula:
Margin-Based Leverage= Total Value of Transaction/Margin Required
For instance, if you have to deposit …show more content…
Whether a trader is required to put up 1 or 2% of the transaction value as margin may not influence his or her profits or losses. This is because the investor can always attribute more than the required margin for any position. And you need to look not at margin-based leverage but at the real leverage. In order to calculate real leverage follow this formula:
Real Leverage= Total Value of Transaction/Total Trading Capital
For instance, if you have 10000 $ in your account, and you open 100000$ position, you will be trading with a 10 times leverage on your account. In case you trade two standard lots, which is worth $200,000 in face value with $10,000 in your account, then your leverage on the account is 20 times (200,000/10,000).
It means also that the margin-based leverage is equal to the maximum real leverage possible to be used by a trader. Usually, traders’ real leverage is different from their margin-based leverage because most of traders do not use their complete accounts as margin of each of their …show more content…
For instance, when a currency pair GBP/USD moves 100 pips from 1.9500 to 1.9600 this is just a one cent move of the exchange rate. Exactly for this reason, currency transactions should be done in big amounts in order to transform these price movements in big profits using the leverage advantage.
If you are involved with such big amount as 100000$ , then even small changes in the price may have big losses or profits.
You have all the freedom and flexibility to select your real leverage amount in trading based on your personality and trading style.
Risk of Excessive Real Leverage
Real leverage has the power to increase your profits or losses by the same amount. So the risk is higher when you apply big amount of leverage on the capital. Be aware that the risk does not have to be directly related to margin-based leverage even though it can have some impact if the trader is not very careful.
We are going to illustrate this point with an example ( See Figure 1).
Trader A and Trader B have a trading capital of US$10000 and both of them trade with a broker that requires a 1 % margin deposit. Then, they agree that USD/JPY is reaching a top and should fall in value. Thus both of them short the USD/JPY at