A complete review of leverage in the forex market

What is leverage in the Forex market and important recommendations for using leverage in Forex trading

One of the attractive concepts in the forex market that has made many people interested in investing in this market is leverage. Leverage allows traders to trade multiple times their account balance and earn good profits in suitable opportunities. Although using leverage increases the profitability of traders, it will also result in heavy losses at times. Stay tuned to learn about leverage in financial markets.

Contents

What is leverage in Forex?

Leverage in the forex market is a tool that the broker provides to traders so they can trade several times their capital and balance. Assume a trader has 1000$ in balance, and the price of one-ounce gold is 1600$. He cannot buy an ounce of gold with his available credit. With the help of leverage, brokers can allow him to purchase gold ounces, much more than his account balance. For example, when a trader uses 1000 leverage, they will have 1000 times their assets, that is 1,000,000$, which the broker has lent to them. But note that the trader must not lose more than his initial balance, i.e., $1000. If he loses $1000, the broker will close all open positions and retract the loaned money.

Therefore, using high leverage can bring good profit to traders, provided that this tool is used correctly and with capital management. On the other hand, if the risk and capital management are not observed, the traders' capital might become zero with the lowest market volatility. Leverage is like a double-edged sword, and it depends on the skill of the person who uses it.

Read more: 12 golden tips for capital management in forex

Leverage in brokers

Brokers usually offer different ratios for leverage depending on your broker. Brokers can specify specific rules regarding leverage according to the balance and account conditions. "Why do brokers lend such credit to traders in the form of loans?" question may occur to you.

The main reason is that earning profit without leverage in the forex market requires a lot of capital, and most small traders cannot provide such capital. Therefore, brokers provide conditions for small traders to trade in forex with less capital in the form of trading leverage.

In Trendo Broker, the lowest leverage is 1:25, and the highest is 1:1000. The capital that Trendo Broker provides to traders with Leverage is calculated based on the initial balance of the trader's account. Also, Trendo Broker has included rules to preserve the capital of its customers in high-risk situations, and in critical situations, such as when economic news is published, the leverage ratio of trading accounts is reduced to 1:100.

Read more: What is the economic calendar in Forex? (How to use the economic calendar)

Connection between leverage and trading margin

Brokers receive a deposit from traders, which is called a margin. Brokers provide the capital they provide traders with leverage in the form of margin. This money is not cut from the trader's balance but from the trader's free margin, and after closing the transaction, it returns to the trader's free margin after taking the profit or loss into account.

Margin's relationship with leverage is reversed. The higher the account leverage, the less margin is needed for trading. Consider two traders who both have $1,000 in balance with the difference that the account number of the first person is 1:100 and the second person is 1:1000. For example, in buying a 0.01 lot of the EURUSD currency pair, the first person needs $10 of free margin, and the second person needs $1 of free margin. Therefore, the second person can open more trades, and the probability of his profit is higher.

Read more: What is margin in Forex?

In another example, suppose two traders in Trendo Broker have a balance of $1000 in their account. Therefore, according to the image below, they have $1,000 of free margin for trading.

The first trader has an account with a leverage of 1:100. The trader opens a gold buy transaction in his account with a volume of 0.5 lots. As you can see in the picture, a $962 margin was used for this trade. In other words, for 100 leverage, a $19.2 margin is needed for every 0.01 lot of gold purchased in Trendo Broker.

Currently, the desired trade is in profit, this account's free margin is $65.98. If the trader wants to calculate how many more lots he can buy in the gold symbol, he can divide his free margin by the required margin for 0.01 lot of gold purchase. Therefore, the trader can trade another 0.04 lots in gold with this free margin.

The second trader has an account with a leverage of 1:1000. The trader opens a gold buy transaction in his account with a volume of 0.5 lots. As you can see in the picture, a $96 margin was used for this trade. In other words, for the leverage of 1000 in Trendo Broker, a $1.92 margin is needed for every 0.01 lot of gold purchased. The desired transaction is currently in profit, and this account's free margin is $909.32. If the trader wants to calculate how many more lots he can buy in the gold symbol, he can divide his free margin by the required margin for 0.01 lot of gold purchase. Therefore, the trader can trade another 4.73 lots in gold with this free margin. Note that the higher the account leverage, the less margin is required for trading.

Why should leverage be used in Forex?

The forex market usually has a small fluctuation range in terms of daily changes percentage. For example, the price of gold (XAUUSD) changes by 2-3% in a day at best. In such a situation, traders need a lot of capital when leverage is not provided in the forex market, and the trader's average monthly or annual returns will be very low, and Forex will lose its popularity. So leverage in the forex market is necessary.

Important tips for using Leverage

More than 90% of retail traders lose in the forex market. One of the important reasons for this is using very high leverage in trades. Traders who use high leverage in their trades will eventually lose their accounts. Go to your user account and set the account leverage to a maximum of 1:200 after reading this article. You might currently be in control of your behavior and not act emotionally, but there are moments in the market that mess with every trader's mind. In such cases, if the account leverage is high, the trader will increase the trading volume and lose the account. But, if your account leverage is 1:100 or max 1:200, even if you want to, you cannot open high-volume trades, and the possibility of losing your account will be minimized.

If you are trading with high leverage, you may not lose your account today, but it will happen in the next three months, don't doubt it! So, be sure to reduce your leverage. To better understand the process that takes place, read the following article:

The next piece of advice is to test your strategy and skills on demo accounts before starting to trade with leverage in the forex market. You can start trading in forex risk-free with demo accounts, by easily opening an account in Trendo Broker.

Read more: Tutorial on Opening a Forex Account & Authentication in Trendo

Summary

In this article, we mentioned practically all the points you need to know about leverage and trading credit in the forex market. Leverage allows traders to trade several times their account balance and earn good profits in the right opportunities. On the other hand, it also increases the risk of trading, so professional Forex traders need to understand this concept well and be familiar with the risks of using trading leverage. We recommend never risking more than 2% of your total capital in one trade.