What is Leverage Trading?
In Forex, leverage is a very useful financial tool that allows traders to increase their exposure beyond their initial deposit into the market. This implies that a trader can enter a $100,000 trading position and only require $10,000 with a ten-to –one leverage scenario. Nevertheless, it is important to point out that, leverage can magnify profits or losses. In fact, a trader might even lose more than he has in his deposits in adverse market situations if leverage is used.
Now having a ten-to-one leverage, means that a trader can gain market exposure ten times more than the deposit or margin required to fund that trade.
Takeaway: Leverage is usually expressed in terms of ratios.
|LEVERAGE EXPRESSED IN WORDS||LEVERAGE EXPRESSED AS A RATIO|
Calculating Leverage in FX Trading
To calculate leverage, traders need two information;
1). The notional value of the trade
2). The margin percentage
Leverage= trade size/equity
Where, equity= margin percentage x trade size.
If a trade size equals $100,000 units of currency and the margin percentage is 10%, what is the leverage?
To answer this, the first step is to find what the equity is by multiplying the trade size by the margin percentage.
Equity= trade size x margin percentage
$100,000 x 10% (0.1) = $10,000
But Leverage = trade size/equity
Therefore, Leverage =$100,000/$10,000
= 10 times or 10:1
This example just explains how forex leverage is used when entering a trade. Now, with this understanding, what can be the possible relationship between a leverage and a margin?
Relationship between Leverage and Margins in FX Trading
Every broker have their specific leverage options which they offer to anyone who’s going to be needing their services. Most popular leverage ratios in FX trading include 1:10, 1:20, 1:50, 1:100, or even higher as the case maybe. Take note that, the leverage ratio determines what position size you can take based on the size of your trading account. For instance, a 1:100 allows you take a position 100 times higher than your trading account size. For example, if you have a trading account of $1,000, you can take a position worth $100,000.
What stands to make margin and leverage related is the fact that as more margin is required, the less leverage traders will be able to use. Simply put, there’s an inverse relationship between margin and leverage because the trader will have to fund more of the trade with his personal money which makes him borrow less from the broker.
|MARGIN REQUIRED||LEVRAGE RATIO|
This table further expatiates the relationship between leverage and margin. As can be seen below, the more margin required, the less leverage the traders can use and the higher the leverage ratio used, the less margin will be needed to allocate each trade.