What is Leverage in Trading: Examples and Definition

2024.08.30 2020.07.28 What is Leverage in Trading: Examples and Definition

Oleg Tkachenkohttps://www.litefinance.org/blog/authors/oleg-tkachenko/

Leverage is a kind of interest-free loan provided by a broker. You can use leverage to increase the size of your position, and so, increase the returns. Or, you can use leverage to reduce margin (the collateral demanded by the broker for the position opened).

Read on and you will learn what is leverage and how it works. You will also learn how to calculate and find out the most optimal leverage. I will cover all the pros and cons of leverage trading and give real examples of leverage forex trading. 

Major takeaways

You will find very useful and interesting information about what is leverage in forex!

What is leverage? Leverage Definition & Meaning

Imagine that you buy apples in the wholesale market in a big city and sell them in a local market in a small town. It is clear that have a certain extra charge for providing the service of moving apples from the wholesale market to the small town. 

And the more apples you can buy in the wholesale market, the more you will earn on the markup (provided that all the apples are sold out). But you have a limited amount of cash. You understand that you can sell 5 times more apples in the local market, and you go to a bank to take a loan. 

Forex leverage explained in simple terms is a kind of the bank loan provided by the broker to the forex trader. If you have a relatively small deposit and use the leverage, you can buy several times more currency or stocks, and so, make several times more profit. 

What is Leverage in Forex?

But there is a significant difference between a bank loan and the forex leveraging. A forex trader can use leverage any time for free, the broker provides the loan with no interest charged on the amount of debt.

Financial leverage in FX trading is: 

• An option that allows a trader to enter trades with a volume several times larger than the actual amount of money on the trading deposit.

• An instrument of margin trading, which is the funds you borrow to increase the position volume, and so, to increase your profit, in case your equity is not enough.

• The ratio between your deposit and the position volume you are opening. 

The maximum Forex leverage is specified in trading conditions for each type of trading account. For example, the maximum leverage for one account is 1:200; for another account, it will be 1:1000.

An example of leverage in forex: 

1. A 1:1 leverage means that the trader trades only with own funds. The ratio between the trader’s deposit and the amount of money he/she trades. That is, if the trader has $100, he/she cannot open a position with a total volume of more than $100.

2. A 1:1000 leverage means that the trader can open a position of 1000 times more volume than the funds he or she owns. It means, if you have $100, you can open a position of $100*1000 = $100 000. 

Which leverage is the safest? The minimum allowable leverage is 1:1.

There is no upper limit, in theory, that is why you can come across the Forex leverage of 1:3000. However, financial regulators strongly recommend brokers to lower the maximum limit of leverage to reduce the risk of losing the trader’s deposit.

Leverage vs. Margin - the Difference & Relationship

Another definition of leverage is the option that increases the trader’s funds given as collateral to open and maintain a position.

For example, a 1:100 operating leverage, in this case, means that to open a position of 1000 units of the basic currency, the trader will need 100 times less money, which is 10 units.

This amount of money is called margin, which is the sum blocked by the broker until the opened position is closed.

Margin is the money needed as collateral that you should have on your account to be able to trade Forex using leverage.

The general formula to calculate margin looks like this:

Margin = position volume (contract size, lot) / leverage

For example, if you use the leverage of 1:2 to enter a trade of 100$, the margin requirement will be 00/2 = $50.

Let us study the opened position on the EUR/USD with the leverage of 1:1 as an example: 

Assets total. This is the amount of funds on the trader’s deposit that is equal to the balance (the deposit amount at the time of the position opening + profit/loss yielded by the opened positions). That is the amount that will be on the account if the positions are closed right away. While positions are open, the amount is floating.

Assets used (margin, collateral). These are the funds the broker blocks when you enter a trade. This the amount of your deposit that directly relates to the leverage.

Available for operations funds is the amount of free money that the trader can use. It is calculated as the difference between equity and margin. The amount is floating, as it takes into account the current profit/loss on the open positions.

In this example, I entered a trade a minimum lot of 0.01 (a smaller volume is not provided for by trading conditions), which required $ 1,127.21. This amount is reflected in the line "ASSETS USED" and I have a little more than $872 of free money. It means that I cannot enter another, I just do not have enough money.

I open the same demo account, but with leverage of 1:10 and enter three trades with a volume of 0.01 lots. With leverage of 1:10, I need 10 times less money to enter a similar trade with the same effect. So, I can enter 10 trades with a volume of 0.01 lots at the same time (for example, for several instruments). Or I can enter one trade, but with a volume of 0.1 lot.

We should have a minimum deposit of lightly more than $1127.21 to enter a trade with a minimum volume of 0.01 lots with a 1: 1 leverage. With leverage of 1:1000, the margin would be $ 1,1272. That is, the amount of my own funds of $ 1.13 would be enough to enter such a trade. 

A short summary. Margin is the amount of money set aside by the broker when the trader enters a trade. It can be presented as a table: 

If you trade with a 1:1 leverage, the margin requirement is equal to the position volume (the broker holds collateral of 100% of the full amount of the position).

With a 1:100 leverage, if you enter the trade with the same volume, the broker sets aside only 1% of the full amount of the position. 

Why Trade with Leverage on Forex Market?

You can trade without any leverage at all. However, there are situations when leverage makes it much easier to reach your financial targets or/and increase your profits. For example: 

• You can open a position with the minimum allowable volume (it is usually 0.01 lots) even if you have a small deposit. You can’t enter a trade on some assets without leverage when you have a deposit of 10$ (or even 100$). SO, financial leverage could be the only chance for a newbie to start trading. You will know more about this in the next part.
• You can boost the volume of your position. Imagine that your deposit allows you to enter the trade on the EUR/USD with a volume of 0.01 lots, where 1 pip is 10 cents (for four-digit quotes). 

Here’s an example: You are 100% sure that the price will cover 10 points in the needed direction. Without leverage, you will gain 10*10 = 100 cents ($1). Take the Forex leverage 1:100 and enter a trade 100 times bigger, the trade volume of which is 1 lot. Your profit from 10 covered points will also be 100 times more - $100. However, the risk management rules say you should not enter a trade for the entire amount of your deposit, but this is just an example, to demonstrate how leverage works in Forex trading.

• You can enter more trades, and so, boost your deposit. An example: you have $100. When you open a position with a volume of $100 (without leverage), the broker reserves it all right away to keep your position open. The entire deposit amount is blocked, and you cannot enter more trades.

If you employ a 1:10 leverage, then the broker will set aside only $10 for a trade of $100. Then you can use the remaining $90 to enter new trades. For example, you can enter trades on other assets and thus diversify the risks. 

You will better understand what Forex leverage is if you open a few demo accounts with different deposits, different leverages, and enter a few different trades.

You can do it by going through a few easy steps: 

• register a profile with LiteFinance (click on the Registration button on the top right corner). It won’t take more than a couple of minutes.
• click on the METATRADER tab on the right of your trading chart in your client profile. 

Click on the OPEN ACCOUNT button, choose the leverage, and, after creating the account, set it as the main account. Therefore, you will open both a real and a demo account. To switch from one account to another, go to the Metatrader tab again and turn the required account into the main one.

The demo account provides a leverage range from 1: 1 to 1:1000. On real trading accounts (Classic and ECN) a leverage range is also from 1:1 to 1:1000.

How to check your account leverage in the MT4 platform? There is not such an option directly in the MT4 (it doesn’t make sense to calculate based on the margin level). 

Such an option is provided in the trader profile, where you can also open an MT4 account and attach it to the terminal having a login and a password. You can see the leverage for each account in your profile. You can also alter the leverage entering the Metatrader menu on the right. 

How Does Leveraging Work in Forex Trading?

Let us see how Forex leverage works on the example of a real situation from the LiteFinance trading platform.

Suppose you have deposited $100 in your investor account and want to enter a trade on the EUR/USD currency pair, whose current exchange is 1.13. According to the trading conditions, the minimum trade volume is 0.01 lot. 

According to the trading conditions, the minimum transaction volume is 0.01 lot. Since 1 lot is 100,000 base currency units, the trade volume of 0.01 lot will correspond to 1000 units. That is, a trading volume of 0.01 lot means that you can buy at least 1000 euros, for which you will need more than $1130. But you have only $100 on your account, and the platform simply won't let you open an order.

If you use the leverage of 1:10, you can already manage $1000. But it is yet not enough. It is clear from the figure, having a deposit of $1000 you receive the message the funds on your account are not enough? And you cannot open the position.

When you use the leverage of 1:20 (it is quite a safe leverage for a beginner trader in terms of risk management), you will be able to enter a trade with a volume of 0.02 lots.

Leverage Pros

Pros of leveraged trading in Forex: 

1. You can enter trades with the volume much larger than your own capital.

2. Leverage is an interest-free loan. To boost your deposit amount and enter trades with a larger volume, you can take a loan in a bank, but you will have to pay interest. Forex brokers do not charge interest for providing you with leverage.

3. You can increase your gains using leverage. If you increase your trade volume by 10 times using leverage, you will increase your profits also ten times (I wrote this before).

4. With the same trade volumes for the same asset, the deposit without leverage will be stopped out sooner than the trading deposit with the leverage. 

Leverage Cons

The cons of trading with Forex leverage include: 

1. Higher risks associated with the boost in the total volume of open trades. An increase in the volume of positions also increases the value of a point. Therefore, your potential losses are also amplified. High leverage implies high potential profit as well as high potential losses.

2. A margin call/stop-out. This problem stems from the previous point. If you enter the EUR/USD trade with a volume of 1 lot, one point costs $10. 

   If the position volume is 0.01 lots, one point costs 10 cents. In the first case, the deposit will be stopped-out much faster.

3. Psychological trap. When you have free funds spared from the margin requirement with the help of leverage. It can encourage you to boost your position volume adding up to a losing trade if you want to win back your losses. It can also result in unjustified confidence in potential profit.

Important!All the cons of leverage above are the drawbacks only when a trader forgets about the rules of risk management and increases the position volume being ruled by emotions. If you employ the broker’s leverage (even high leverage) without making the position volume bigger, it is not associated with any risks.

Leveraged Products (how to calculate leverage for different trading assets)

So, now I believe you understand the general meaning of margin and leverage. Let me summarize briefly:  

• Financial leverage is the interest-free loan provided by the broker, which allows buying much more assets or to reduce the margin, sparing the funds that would be reserved by the broker as collateral.
• Margin is the trader’s funds reserved by the broker as collateral (real funds on your account) when he/she enters a trade. It is calculated according to the formula Position volume/Leverage.
• A stop out in Forex is the level at which all of a trader's active positions are closed automatically by their broker, It is calculated as a percentage of the Level established by the trading conditions. The level, in turn, is calculated as Assets total (or funds total)/Assets used (Margin, collateral)*100. 

The above concepts are needed to develop the risk management system and calculate the acceptable level of risk. The above formula is relevant only for currency CFDs traded in Forex. For other trading instruments, the calculation formula is different. Likewise, the concept of leverage in the stock exchange, for example, is different from the definition of the Forex leverage as the borrowed funds provided by the broker. 

1. Currency trading (direct quotes, indirect quotes, and cross rates)

1.1. Direct quotes. 

A direct quote is a foreign exchange rate where the USD is in second place in the fraction.

An example. The EUR/USD currency pair refers to direct quotes.

The exchange rate 1.13 means that the trader needs $113,000 to buy 1 lot (100 000 euros). 

Or $ 1130 for a minimum trade volume of 0.01 (1000 euros).

With a 1:100 leverage, the margin will be 0.01*100,000/100*1,13, where:

• 1000 - euros, the volume of the currency being bought (position volume).
• 100 - Leverage.
• 1.13 — the exchange rate.

The margin requirement will be $11.3.

That is a hundredth of the amount of money that a trader will spend to buy 1000 euros (0.01 lot).

1.2. Indirect quotes  

An indirect quote is the currency quote where the USD is in the first place.

An example: The USD/CAD currency pair is an indirect quote.

Since the collateral is calculated in the first currency for this currency pair, in this case, it will be calculated in USD.

A 0.01 lot trade means that the trader will need $1000 to buy the Canadian dollar.

With a leverage of 1: 100, the margin is: 0.01 * 100,000 / 100 = $10.

1.3. Cross-rates. 

A cross-rate is a currency exchange rate that doesn’t include the USD. But the collateral here is also calculated in the currency that is in the first place in the ratio.

An example: The GBP/CAD currency pair is a cross-rate.

0.01 lot means that a trader buys 1000 pounds for Canadian dollars according to the market rate. As the trader’s base currency is the US dollar, the amount of money indicated in the Assets Used section will be expressed in the USD.

With a 1:200 leverage, the margin is 0.01*100 000/200*1.2639 = 6.319

• 1000 - minimum lot (0.01).
• 200 - leverage.
• 1.2639 - GBP/USD exchange rate (a slight deviation from the figures in the screenshot results from the floating rate).

This margin value you see on the screen, in the Assets Used tab.

2. ETFs

There is a significant difference in how the leverage is applied to the exchange market, which is authorised and regulated, and over-the-counter market. 

2.1. Exchange-traded indexes. 

ETF is an index fund whose shares are traded on an exchange. It is based on a structured portfolio of assets, often having fixed costs.

Buying shares of an ETF fund, a trader actually invests in a consolidated investment portfolio, which can have a diversified structure or consist of instruments of a certain segment.

A leveraged ETF allows you to increase the profitability of the shares by the leverage size. For example, if you invest in a NASDAQ ETF without leverage, you will have a 1% profit if the index rises by 1%. If you invest in an ETF using leverage, you will make 2%-3% profit from the index growth by 1%. Such ETFs are also referred to as margin trading ones. 

2.2 Forex indices.

You can also trade indices with a Forex broker. The advantage of Forex index trading is that there is a lower entry threshold and less formal procedure ruled. Trades are entered in a couple of clicks.

All the data needed for calculation from the contract specification, which you can find in the trading instrument information on the LiteFinance website. 

Choose an instrument you want to know the specification on. In this case, it's the FTSE index.

Position volume is the volume you are going to buy in lots. The contract size, point size, margin percentage – all these data are found in the contract specification. The margin percentage of 1% means that 1:100 leverage is used on the instrument.

Collateral (margin) = 1*1*6111.7/0.1*0.01*1/100 = 6.1117, where:

• 1 – position volume. It corresponds to 1 lot, you cannot set a smaller volume.
• 1 – contract size, specification data.
• 6111.7 – contract price.
• 0.1 – tick size.
• 0.01 – tick value. Note that the MT4 screenshot displays 0 in this section. This is the flaw of the platform, which rounded the value down for this contract. 
• 1 – margin percentage. It is an analogue of leverage. 

As the margin currency is the GBP, and the deposit currency is the US dollar. We shall correct the exchange rate, 6.1117*1.2639 = 7.73. That is the margin requirement for the contract expressed in the USD.

Important! Note that in Forex indices trading, the leverage does not matter, since it does not take part in the margin calculation formula. 

The so-called margin percentage is considered here. The margin percentage is set by the broker for each index. The percentage depends on the liquidity provider. The position amount is corrected by this coefficient.

In this case, the margin percentage can be called an analog of leverage. This is the percentage taken from the margin if we assume that there is no leverage. 

For example, the margin percentage of 10% corresponds to the 1:10 leverage. The margin percentage of 1% corresponds to the 1:100 leverage. You will see how it works in more detail further when I explain the examples of particular assets.  

3. CFDs 

CFD is a contract for difference, this is the major instrument traded in the Forex (it is also popular in exchange markets).

Trading CFD products doesn't require a real exchange of shares, metals, or other commodities, for example, oil. When the transaction expires, the current price is compared with the price relevant at the time of the contract conclusion. The buyer and the seller make the mutual settlement. 

Another advantage of Forex CFD trading is high leverage, which allows boosting position volumes by 100 and even 1000 times. It refers to CFDs on currency pairs. In trading oil CFDs or shares, the leverage works differently. 

You take all the needed data from the contract specification. Note that in the specification of the oil contract, you should specify the type of the margin calculation. It depends on the liquidity provider and can be calculated using the index formula presented in the previous section.

Margin (assets used) = 0.1*10*43.3*10/100 = 4.33, where

• 0,1 - the minimum possible position volume.
• 10 — contract size found in the specification.
• 43.3 - price.
• 10 — margin percentage from the specification.

The leverage of the trading account doesn’t matter here too. But in fact, the leverage here is 1 to 10, which is not provided by any exchange. 

4. Options 

An option is an exchange contract that is concluded between two parties and gives its buyer the right to buy or sell an asset in the future at a preset price and date (the expiration date).

The leverage works in options trading in the following way: the cost of options contracts is typically much lower than the cost of their underlying security. 

Buying options contracts allows you to manage a greater amount of the underlying security, such as stocks than you could by actually trading the stocks themselves.

For example, having the same amount of money, you could buy 10 shares or an option to control 100 shares. If you use leverage in trading options you can create the potential for far higher profits through buying options than you could through buying stocks. 

5. Crypto 

5.1. Cryptocurrency exchanges 

In crypto exchanges, the leverage works in the same way as in Forex trading, it is used to increase the volume of the positions you open. However, exchanges are not as generous as brokers. Most often there are leverages of 1:2 -1:5.

5.2. Trading crypto with a Forex broker

Compared to crypto exchanges, trading cryptocurrencies with Forex brokers has several advantages:

1. Verification is much easier here, there is regulation and protection of the client balance, while cryptocurrency exchanges have been repeatedly hacked and scammed.
2. You can open short positions (sell trades) with a broker.
3. Brokers have higher leverage (margin percentage). A certain margin percentage serves as leverage and is 1 to 10. Let's have a look at how margin in crypto trading with a broker is calculated

Collateral = 0.01*1*9213.12*10/100 = 9.21, where

• 0.01 — Position volume (the minimum lot is 0.01, it is more convenient the trading instruments where the lot volume starts with its integer value).
• 1 — Contract size, taken from the specification in the MT4.
• 9213.12 — the BTC/USD price.
• 10 — margin percentage, also taken from the specification. 

Margin currency is the USD, so the result will correspond to the deposit currency. 

6. Futures

Like stock indices, futures are traded both on the exchange and over-the-counter. 

6.1. Stock exchange market

Unlike the leverage in stock trading, where the broker provides a 1: 2 leverage maximum and charges interest when the position is rolled over to the next day, leverage in futures trading is free. This follows from the concept of the futures itself, where the settlement is made at the end of the contract. 

For example, if the cost of a CAD/USD futures contract is $7,370, then you do not need to pay the entire amount at once. It is enough to deposit a guarantee on the exchange, for example, $737 with a 1:10 leverage.

6.2. The OTC market 

Here, everything also depends on the Margin percentage set by the broker.

7. Metals 

This is another example of how important it is to pay attention to the type of margin calculation in the specification. This line defines the formula for calculating the margin. Metals and oil are referred to as commodity markets. 

However, the CFD formula is used to calculate margin requirements for oil, gold, and silver, while palladium, for example, is an exception. It uses the CFD-Leverage formula, that is, the Forex leverage is taken into account.

Margin = 0.01*100*1949.16/200 = 9.75, where:

• 0.01 - position volume (minimum lot - 0.01).

• 100 - the contract size defined in the specification.

• 1946.16 - the current price at which the position is opened.

• 200 - leverage 1:200.

Unlike oil or indices, leverage is important in trading metals. I would like to emphasize that it is you who chooses the leverage, and you can change it at any moment.

The margin percentage is a fixed value set by the broker and specified in the instrument specification.

8. Stocks 

Like other types of securities, it is possible to make money on changes in the value of the shares both on exchanges and in over-the-counter markets.

8.1. Trading equities on the stock exchange 

When buying shares on the exchange, the trader becomes their direct owner. 

However, the minimum deposit to trade on an exchange can start from several thousand US dollars, and commission fees for beginner traders are sometimes too high. Leverage is provided by a broker, but it is usually low, about 1:2.

8.2. Trading equities in Forex 

Unlike trading in the stock market, there is a low initial deposit. Instead of leverage, the margin depends on the margin percentage.

The formula for calculating the margin for trading shares in Forex is similar to the formula for the margin calculation for CFDs

Margin = 0.01*1*117.23*2/100 = 0.0234, where:

• 0.01 - the minimum position volume for this instrument.
• 1 - the contract size. It is the constant taken from the specification.
• 117.23 - position opening price.
• 2 - margin percentage. It is defined in the specification.

Leverage Ratio: What is this?

In economics, the financial leverage ratio shows the real ratio of own and borrowed funds in a business. This indicator allows you to assess the stability of the company and its profitability level. In Forex, this term has a bit of a different meaning. Forex leverage is the equity ratio for a margin purchase.

Leverage ratio formula

The coefficient formula is simple: 1 / leverage. For example, the leverage ratio for a 1: 2 leverage is 1/2 = 0.5. For a 1: 100 leverage, the leverage ratio is 1/100 = 0.01.

An example of calculating margin requirements and account balance:

1. You have a deposit of $3000. You want to buy 1 lot of the euro (100 000 EUR) at a price of 1.2 USD. The broker offers for this pair the maximum leverage of 1:50. 

   The leverage ratio is 1/50 = 0.02.

   Margin = 100,000 * 1.2 * 0.02 = $2400 - this is the amount of money that will be reserved by the broker at 1:50 leverage.

2. Free funds (available for operations) are 3000-2400 = $600.
3. With the leverage of 1:50, you can manage the funds of 600 * 50 = $30,000. With this money, you can buy 30,000 / 1.2 = 25,000 euros. In other words, the margin for buying 25,000 euros at a leverage of 1:50 would be $600.

For the amount of $3000 with the leverage of 1:50, you can buy 125,000 euros in total. A simplified calculation will look like this: purchase amount = 3000 * 50 / 1.2 = 125,000 EUR. 

Before calculating optimal Forex leverage, I recommend using the forex calculator, which has a lot of other useful information in addition to the margin data. It looks like this:

Forex leverage calculator

Don't know how to calculate leverage in the Forex market? Use the leverage calculator. It's extremely easy to use:

1. Choose a currency pair or any other asset you are going to trade.
2. Choose the leverage you are going to use.
3. Choose the lot size of the position you are going to open.

That's it. The calculator will show the amount of margin you will need to open a trade with the chosen leverage and, apart from that, the real cost of such trade if no borrowed capital is used.

For example, to open a buy position on the EUR/USD with a volume of 0.01 lots and a 1:100 leverage, the margin will be $11.32. Differently put, to buy 1000 EUR, you need $1132, but 1/100 of this amount, $ 11.32, is enough to enter the trade.

Try it yourself:

You may also be interested in other articles that will help you calculate the optimal position volume, taking into account the individual level of risk:

How to calculate a lot in Forex?

How to calculate the margin level in Forex?

Leverage Ratios Examples in Trading

To explain to you the difference between a low leverage trading and a high forex leverage trading, I will again use the EUR/USD pair as an example. I will use a 1:10 leverage and a 1:1000 Forex leverage.

There is a little less than $ 10,000 on the deposit. It means that with leverage of 1:10, I can enter a trade with a volume of 0.8 lots (collateral = 80,000 / 10 * 1.13 = 9040).

Assets available for operations are a little less than $1000. Note the current change. In a few minutes of the trade being held in the market, the floating loss amounted to a two-digit number.

Now, I change my leverage to 1:1000. With the same deposit, I can open a position for 80 (!) lots (collateral = 8,000,000 / 1,000 * 1.13 = 9040). That is, having a deposit of a little less than 10,000 USD, I can buy 8 million EUR.

Now, the current profit/loss is a three-digit number, although the amount of assets used is the same. However, the amount of the assets available for operations is much less, as the point value is much higher because of higher leverage. I wait a few minutes and exit the trade. 

The above figure displays the results of two trades with leverage of 1:10 and that of 1:1000. The positions were held for just a few minutes. The deposit is the same, as well as the collateral. In the first case, the profit is $0.8, in the second case, it is $2800.

At first, the advantage of high leverage seems obvious. But remember that as the trade size increases, the pip value also increases.

In the case of the lower leverage, the available funds are almost $900. In the case of very high leverage, there is less than $150 is available for operations. 

If the price goes just a few points in the opposite direction, the trade will stop-out. With the leverage of 1:10, the price range is much longer, so the trade is much safer. 

Conclusion. The higher is the leverage used to increase the volume of the transaction, the greater is the potential profit. However, there is also a greater risk that the trade will be stopped-out and the deposit will be lost. 

I will further explain how to choose the level of leverage and how to use leverage in Forex trading. 

Using Maximum Leverage Examples

Example 1. Imagine that you pick up a good moment when the EUR/USD trend starts. You have $120 on your deposit and the current exchange rate is 1.2. You take a 1:1000 leverage and you already have $120,000 and you can buy 100,000 EUR (that is 1 lot). The EUR/USD pip value for the trade volume of 1 lot is $10. 

It means that, if the price covers just 12 pips, all the deposit will be lost (let’s assume the stop out level is 0). You open the volatility calculator and see that the EUR/USD average volatility is about 80 pips.

Conclusion. If you use a 1:1000 leverage, you are likely to lose the entire deposit. In case of the trend reversal or a local correction, the price will surely cover 12 pips. 

Example 2. Imagine you have $1200 in your deposit, So, you can enter one trade with a volume of 0.01 lots. Without leverage (a 1:1 leverage), the margin will be $1200. But you want to hedge against the risk and enter another trade for a negatively correlated asset.

You take a 1:1000 leverage, the margin will be $1.2. You can freely control the remaining $1198.8 and enter a trade for another asset with the same volume of 0.01 lots.

Conclusion. Using the maximum Forex leverage, you do not risk anything, as the total volume of the trades entered will be 0.02 lots (the pip value will be calculated in cents and the opposite price movement will not destroy the deposit). On the other hand, your profit won’t be much too. 

Example 3. The position amount for each of the 2 orders is $5000. The first position is opened with a 1:1 leverage, the margin is $5000. The second position is opened with a 1:100 leverage, and the margin is $50. the level formula is Equity/Margin*100%. Stop-out is the level, at which all the positions will be forcibly closed (for example, a stop-out level of 20% means that upon reaching the 20% Level, all positions will be closed automatically). 

Since the amount of an open position (numerator) is the same in both cases, the only difference is in the denominator. Therefore, in the first case, the Level value will be greater than in the second.

Conclusion. With the same volume of positions in the event of a loss, the position with leverage will be stopped-out later than without it. Differently put, using leverage will reduce the risk of a stop-out.  

The Risks of High Leverage

There is only one major risk of trading with leverage. If the leverage is used to increase the total volume of the position, the potential loss grows proportionally to it. On the one hand, high leverage is an opportunity to make a lot of money in Forex, on the other hand, you can quickly lose your deposit.

Advise: 

To lower the high-leverage trading risks do not use all the deposit at once. Use no more than 2% of your deposit for each trade.

Using Less Leverage Examples

Example 1. The EUR/USD exchange rate is 1.2. Your deposit is $1200. If you open a position with the minimum possible volume of 0.01 lot, the margin will be $ 1200, free funds available for operation are equal to zero. 

Suppose you doubt the direction of price movement and want to lock this position without topping up the deposit with real money. 

You take a 1:2 leverage. This reduces the amount of the collateral by half. So, you will have more assets available for operation and you can open a second equivalent position to lock the first trade.

Conclusion. Low leverage can be beneficial in some cases when you do not have enough of your own funds.

Example 2. With the same inputs, you open a position with a volume of 0.01 points. But your forecast has been wrong and the price goes 10 pips in the opposite direction. The pip value for 0.01 lot EUR/USD with 4-digit quotes is 10 cents, your loss is $ 1. Next, you take a 1:2 leverage and open a position of 0.02 lots with the same margin. The price move by 10 pips yields you $2 of profit, compensating for the previous loss.

Conclusion. In some cases, Forex leverage can help you to compensate for the loss, by doubling the position volume according to the Martingale way. 

What is the Best Leverage to Trade Forex? 

As practice shows, more than 40% of traders prefer leverage up to 1:10, about 17% use leverage more than 1:100. European regulators for several trading instruments recommend the Forex brokers to limit the maximum leverage to 1:20 - 1:50. 

Cryptocurrency exchanges most commonly set leverage of 1:2 - 1:5. Leverages up to 1:1000 are chosen by traders ruled by an emotional desire to increase the position volume to the maximum possible without enough of own funds in the deposit. I usually do not seriously consider brokers, which offer leverage more than 1000.

I will recommend beginners to start with the minimum leverage value of 1:1 on a demo account.

Before trading with borrowed funds, a trader should first: 

• Learn to build and adjust the risk management strategy for each trading system. They should cautiously increase risks in calm trending markets and reduce risks in case of strong volatility.
• Learn to employ different trading systems, use indicators, operate on trading platforms, and so on.
• Learn to control emotions, eliminating greed, excitement, and the desire to win back the loss. 

Only when beginners are confident in their skills and abilities and can do all the above, they can start trading on a real account. On a real account, good leverage for a beginner is 1:10. This forex leverage will allow them to open postions of a minimum lot of 0.01 having a relatively small deposit. 

What leverage do professional traders use? Only experienced traders themselves can answer this question. Traders employing forex pipsing and scalping strategies often use high leverages. Their profits are a few pips with short stops, so the high pip value is important for them, which is determined by a large position volume.

Traders who prefer long-term trading strategies try not to use high leverages. So, you should yourself consider whether to use high leverage or low leverage. You can learn more about how to choose the best leverage to trade Forex here.

How to Manage Leverage Risk on Forex: 5 Tips for Beginners

A few tips for beginner traders:

• Follow the primary risk management rule “do not risk more than 5%of the deposit per trade”. It is about the ratio of the position volume and size of the stop loss. For example, for a $ 1000 deposit, the risk per trade should not be more than $50. This corresponds to 5 points for a trade volume of 1 lot (1:100 leverage) or 500 points for a position of 0.01 lot (1:2 leverage). According to the volatility calculator, the daily price change for the EUR/USD pair is 80 pips. This means that with a trade volume of 1 lot, the “risk of 5%” rule will be violated.
• Use forex calculators to calculate the lot and the margin. They will help you to find out the amount of free funds and what leverage is safe on your situation. 
• Use stop loss. If you have made a mistake with the leverage and the pip value turned out to be much higher, the stop loss will close the position in time. You will learn a lesson without losing your deposit.
• Control your emotions. Do not use the leverage to boost your position volume trading the Martingale way. Do not boost the position volume if it contradicts the risk management rules, even if you are 100% sure that it will be profitable. 
• Train your trading skills on a demo account. Choose the most suitable leverage, which corresponds to your trading style, and trade on a demo account. 

What is the best leverage to use in Forex? It is such leverage that will yield you a high profit with your initial deposit and an optimal risk level.

Summary. All the above may seem too complicated at first. Leverage, margin, different calculation formulas, risk management. 

All of this seems difficult until you try it in practice. These are the basic concepts you can’t do without in trading. If you want to learn how to make money on Forex and other markets, let me give you some more recommendations:  

1. Open a demo account. It will take a couple of minutes and doesn’t require verification. Study the functions of the LiteFinance client profile.

2. Try entering first trades with different leverages. See the difference, compare different trading instruments. You should record all your orders in a trader’s diary.

3. Do ask questions and share your ideas! You can write them in the comment sections below this article. You can also study with a trading mentor/tutor, who you can find among your more experienced colleagues who have proved to be successful.

Conclusion

Financial leverage is a tool that allows a trader to boost the position volume or to reduce the margin requirement (collateral), thus sparing the funds to open other positions. Leverage is a high-risk trading tool if the total volume of positions exceeds the deposit percentage suggested by the risk management system. 

To calculate optimal leverage, one can use the forex margin calculator or make up an Excel table, which will demonstrate the change in the position volume with an increase in the leverage. So that you will see the biggest price move in pips to reach a stop-out level.

Do you have any questions on how to trade in Forex with leverage? Write your questions or conclusions in the comments! 

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