What is Leverage in Forex?

What is leverage? Does size matter?

Forex trading rests on the concept of margin trading. The basic principle here is leverage, the investment strategy of using borrowed money. Any trader, especially a beginner, should be well aware of this term, how to calculate it, and which size is preferable. These concepts directly determine a profit, which a trader gains in the short term from a difference in exchange rates of global currencies.

Leverage

Breaking down leverage

Leverage is money that a trader borrows from a broker against a certain security or margin. By contrast with a bank credit, a size of a margin credit can exceed a security's amount by ten or even thousand times. So, a leverage size can be, for example, 1:50, 1:100 or 1:500. What does leverage like 1:500 actually mean? This is one of the largest leverage sizes on Forex. In other words, a brokerage company can lend an amount which is 500 times bigger than a deposit size. Thus, with a deposit of merely $100 a trader is capable of making transactions as if handling $50,000.

Obviously, leverage is a helpful forex tool that enables a trader to open deals at a greater amount beyond his/her means. In case of a winning trade, a profit gained would be much higher than a trader could have generated, investing his/her own capital.

Leverage 1:100

Leverage 1:500

What leverage size is better?

A leverage size makes a direct impact on a maximum size of a position available for opening. For instance, a trader decided to open a deal on the USD/JPY pair. We should bear in mind that a standard lot with InstaForex equals 10,000 units of a base currency. With leverage of 1:100, a security (or margin) amounts to $100 to open one lot on the USD/JPY pair. With $10,000 available in an account, a trader can open 100 lots at the most.

If a trader sets leverage of 1:500, he/she can open 500 lots on the USD/JPY pair with a smaller margin of $20. In essence, higher leverage implies more modest margin and in this case a trader can manage a bigger number of lots.

No wonder, big leverage increases a chance of boosting profits. However, the other side of the coin is that a deposit could be lost in case the right trend direction is misunderstood. How to make the right decision on leverage? A trader should consider two aspects to minimize risks and at the same time maximize hypothetical profits from trading.

Whatever leverage is set, it would be a bad idea to invest all available funds at once. Ideally, every deal should account for 1% or 2% of a deposit. Make sure you set stop loss, thus you will reduce risks drastically.

Besides, it is always possible to change a leverage size to higher or lower, depending on a preference, forex experience, and risky sentiment. So, you will be able to gain more profits.

It is up to you to choose the best!