Length : 2.00 Minutes
One of the reasons why Forex market is more attractive compare to other financial instruments is the existence of high leverage in the FX market. The higher leverage creates greater opportunity 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. 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 FX market to invest in something. In other words, leverage give the power to the trader to control a huge 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 you are required to put up.
(Margin based leverage = Total value of transaction/Margin required)
For example, to control a $100,000 position (which equals to one standard lot), your broker will set aside $1,000 from your account which is equivalent to only 1% of total value of 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 is the maximum allowed position lot size.
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 his/her account, and he/she opens 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.