The idea and usage of leverage when applied to the world of Forex can be confusing for someone who is new to the game. If that sounds like you, then it is important not to let an offer of leverage from a broker blind you to the very real risks involved in using this strategy.

The Basic Concept:

A standard trading account with a regular broker will usually deal in lots of $100,000. To make a single trade with your account, you are going to need $100,000 to place on it. This figure is beyond the reach of most of us, and so this is why brokers offer leverage.

The way leverage allows us to trade these large lots is by the brokers lending the trader most of the money involved, with the trader putting up a percentage of the trade as security. If the trade falls by more than you put up as collateral then the broker will close your trade and that money will be lost, but if the trade moves in your direction then you stand to make a good profit.

More Details On Leverage In Forex:

You will usually see brokers advertising leverage in the form of 2 numbers separated by a colon, e.g. 100:1. In this case, the figures mean the broker is willing to let you trade with only 1% security. Similarly, 200:1 means they are offering trades with only 0.5% security (1 / 200 * 100(%)) and so on. You may see brokers go as high as 400:1 (0.25%).

Another term that is often used in the company of leverage is the word 'margin'. The margin is always expressed as a percentage, and it is the figure that represents the percentage of the trade required as security. In the case of 100:1 leverage, the margin is 1%. Forex margin trading and leverage trading are generally used interchangeably to refer to the same thing.

Leverage In Use:

From the examples above it should now be clear that leverage could allow you to borrow $99,000 form your broker to make a $100,000 trade, with only $1000 of your own money at risk. Bear in mind thought, that as previously stated, if your trade were to fall by $1000 your trade will close. This is because the broker is protecting himself from a loss on your trade.

Because you traded with a 1% margin, you couldn't afford your trade to drop by more than 1%. The Forex market is a highly volatile one, and movements of 1% are common. Your trade may have turned around and made a profit after it dipped, but your trade was already gone. Because in this example the 1% margin gave you no room to let the market fluctuate a little, you lost out on potential profit. When this happens, it is called being too heavily leveraged.

Avoiding Small Margins And Heavy Leveraging:

Learning more about forex trading strategies that don't put you at risk of being too heavily leveraged is vital in protecting your trading account.

Many traders are using leverage as a way of controlling large lot sizes without the full investment, because they have learned to use it responsibly and to their benefit.