What is Leverage in Forex?
Leverage is what allows you to trade more units than you have.
Imagine you have a mini account with a balance of $1,000 (1,000 units). You enter a trade with $100, and your broker is providing 100:1 leverage. That means you can hold a position up to $10,000 because for every $1 you put in, your broker will put in $99 to make it $100.
The important thing to remember about leverage is that it does not affect the value of a lot. A mini lot is always 10,000 units and a standard lot is always 100,000 units. If you have 400:1 leverage a mini-lot is roughly $1 a pip. With 100:1 leverage, a mini-lot is also roughly $1 a pip.
Leverage has an effect on the number of lots you can have in the market, based on the capital in your account.
The reason we call it leverage is because it is similar to lifting a very heavy object. Some things are just too heavy to lift. But if you get the right leverage, it is easy. Think of a see-saw!
If you have 100:1 leverage, you can trade a mini lot (10,000 units of currency) with just 100 units of your own.
Leverage may sound great but it can also cause problems. The higher your leverage, the more capital you can risk at one time as opposed to having a lower leverage.
Let’s look at two traders who have the same capital, $10,000 USD. Trader A has 400:1 leverage and Trader B has 100:1 leverage. Trader A can risk much more of their $10,000 at one time than Trader B. It also means that Trader A can have less in their account to cover their position.
How about some more detail. Trader A takes a long position at 400:1 leverage and buys 1 mini lot (10,000 units). Trader B takes the same long position at 100:1 leverage and buys 1 mini lot also.
Since Trader B has 100:1 leverage, he is required to have 100/1 or 1% of that position in their account. So that means at least $100 in their account since $100 is 1% of 10,000 (1 mini lot). Trader A has 400:1 leverage so is required to have 400/1 or 0.25% of that position in their account. Trader A needs to have at least $25 in their account which is 0.25% of 10,000 (1 mini lot).
Leverage can be extremely dangerous. If you have a $1,000 account with 400:1 leverage, for just $100 you could trade four mini lots. If you take a 100 pip loss on that trade, you lose $400 which is 40% of your account!