What is Leverage in Forex? Forex Leverage Explained

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What is Leverage in Forex?

What is Leverage in Forex?: Many people are attracted to forex trading due to the amount of leverage that brokers provide.
Leverage allows traders to gain more exposure in financial markets than what they are required to pay
for. Traders of all levels should have a solid grasp of what forex leverage is and how to use it
responsibly. This article explains forex leverage in depth, including how it differs to leverage in stocks,
and the importance of risk management.

What is Leverage in Forex?

WHAT IS LEVERAGE IN FOREX TRADING?

Leverage in forex is a useful financial tool that allows traders to increase their market exposure beyond
the initial investment (deposit). This means a trader can enter a position for $10,000 worth of currency
and only need $1000, in a ten-to-one leverage scenario. However, it is essential to know that gains AND
losses are magnified with the use of leverage. In adverse market scenarios, a trader using leverage
might even lose more money than they have as deposit.

Leverage of ten-to-one means that traders can gain exposure to a notional value or trade size, ten
times more than the deposit/margin that is required to fund the trade. This can be thought of in a
similar fashion to putting a 10% deposit down on a house; you gain access to the entire house while
only funding 10%of the full value.

Leverage is usually expressed as a ratio:

LEVERAGE EXPRESSED IN WORDSLEVERAGE EXPRESSED AS A RATIO
Ten-to-one10:1
Thirty-to-one30:1
Fifty-to-one50:1

The amount of forex leverage available to traders is usually made available through your broker and the
amount of leverage will vary according to regulatory standards that preside in different regions.

Leverage in forex vs leverage in shares

Forex leverage differs to the amount of leverage that is offered when trading shares. This is due to the
fact that the major FX pairs are liquid and typically exhibit less volatility than even the most frequently
traded shares. As a result, hedging risk and getting in and out of trades is more manageable in the $5.1
trillion a day FX market.

HOW IS FOREX LEVERAGE CALCULATED?

Traders require the following to calculate leverage:

  • The notional value of the trade (trade size)
  • The margin percentage

Brokers often provide traders with a margin percentage to calculate the minimum equity needed to
fund the trade. Margin and deposit can be used interchangeably. Once you have the margin
percentage, simply multiply this with the trade size to find the amount of equity needed to place the
trade.

What is Leverage in Forex?

What is Leverage in Forex? The example highlights the basics of how forex leverage is used when entering a trade. However, it
must be noted that traders should not simply calculate the minimum amount needed to enter a trade
and then fund the account with that exact amount. Traders must be mindful of margin calls if the
position moves in the opposite direction, bringing the account equity below an acceptable level
determined by the broker.

Trading forex with leverage has the potential to produce large losses. We have calculated a typical
scenario of how the use of excessive leverage can impact a trading account and tabulated the results.

HOW TO MANAGE FOREX LEVERAGE RISK

Leverage can be described as a two-edged sword, providing both positive and negative outcomes for
forex traders. This is why it is essential to determine the appropriate effective leverage and incorporate
sound risk management.

Top traders make use of stops to limit their downside risk when trading forex. At we r
ecommend risking no more than 1% of the account equity on any single trade and no more than 5%
of the account equity for all open trades at any point in time.

Furthermore, successful traders make use of a positive risk-to-reward ratio in an attempt to achieve
higher probability trades over time.

It is vital to avoid mistakes with leverage; to understand how to avoid other issues traders might face
check our Top Trading Lessons guide.

LEVERAGE TRADING TIPS

  • If you are new to forex be sure to get up to date with the basics of forex trading through our New
    to FX guide.
  • It is highly recommended to make use of stops when trading with leverage. Guaranteed stops 
    eliminate the risk of negative slippage when markets are extremely volatile.
  • Keep leverage to a minimum. At DailyFX we recommend 10% leverage, or less.
  • Understand the margin policy of the forex broker to avoid margin call.
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