Borrowing Capital from your broker to open bigger positions than you would otherwise be able to.
One of the reasons why the Forex market is more attractive compare to other financial instruments is the existence of high leverage in the FX market. The higher leverage creates more significant opportunities but also could lead to higher risk.
Most forex brokers offer a very high leverage ratio, or, to put it differently, they have very low margin requirements. This is why profits and losses can be so great in forex trading. However, while many traders have heard of the word "leverage," few know its definition.
So what is leverage?
Leverage involves borrowing a certain amount of the money from usually the broker in the FX market to invest in something. In other words, leverage gives the power to the trader to control a considerable amount of money with a small deposit.
How to calculate it?
To calculate margin-based leverage, divide the total transaction value by the amount of margin required to put up.
(Margin based leverage = Total value of transaction/Margin required)
For example, to control a $100,000 position (which equals one standard lot), your broker will set aside $1,000 from your account, which is equivalent to only 1% of the total value of the transaction. Then the leverage, which is expressed in ratios, would be 100:1.
You are now controlling $100,000 with only $1,000.
Your account leverage indicates what the maximum allowed position lot size is.
To calculate the REAL LEVERAGE you are currently using, divide the total face value of your open positions by your trading capital.
(Real Leverage = Total value of current transaction / Total trading capital)
For example, if one has $10,000 in their account and they open a $100,000 position or one standard lot, the leverage will be 10:1 (100,000/10,000).
The bottom line is, abuse of offered leverage could lead to heavy losses of capital. Leverage should be used wisely with a proper risk management strategy in place. Higher leverage could negatively affect the physiological factor of trading and lead to emotional trading.