The term leverage refers to two elements. First, the mechanism to make a lot bigger than that for money, an investor has a real position. Second, the expected return on a derivative financial product or forward transaction compared to the return on underlying transactions only in the assets of these products or these futures.
The leverage associated with Forex is much higher than that offered in other financial markets, such as stock markets or commodity markets.
Currency volatility rarely exceeds the 1% per day threshold, which is seen in the currency market as a fairly significant move. Leverage enables significant changes to be made from relatively small market gains. Also, very often, currencies are traded by lot (the amount of a standard lot is 100,000 units of an account for a classic margin).
The use of leverage is almost essential to invest and make money in Forex. Transactions need to be significant enough to take advantage of price differences.
What is the leverage?
Forex brokers offer leverage in the form of prizes. It offers the ability to place a total of $100,000 with a deposit equal to $1,000 account. This is called leverage.
Different levels of leverage are available from broker to broker. The effect of the allowed leverage can vary depending on the broker from 20 to 400 times the amount deposited in the investor’s account. Each investor has the opportunity to choose their leverage in terms of their risk aversion and search for returns.
In turn, the greater the leverage, the greater the importance of the risk involved.
In fact, every change in pip (currency trading point) in the opposite direction of the position taken by the investor will result in a loss far greater than the effect of leverage. If prices move to the detriment of the position taken by the investor, a significant loss of funds may occur. Leverage should be used with extreme caution and in a very reserved way.
An example of leverage
A client has 5050 euros in his open margin account with a broker. It has a leverage of 100. You bought five lots (each lot of 100000 means paying 1000 euros) for the EUR/USD rate of 1.3950. The margin used is 5000 euros.
If the market rolls in your favor and the exchange rate reaches 1.4050 (representing an increase of 100 points), your profit is $5000 (100 points x $10 per point X 5), an increase of 3558 euros (5000/1.4050). The yield is 70% compared to 5050 euros deposited in your account. Of course, the risk is in the event that the exchange rate moves against it. Therefore, if the exchange rate reaches 1.3850 (range 100 points down), it shows a loss of 3610 euros (100 points x $10 per point X 5/1.3850), the initial capital of the traders can suffer big losses. If the trader wants to sustain his position, he will definitely need to invest more funds.
To conclude, leverage is a very powerful tool and can help generate huge profits only and, if used wisely and, of course, sparingly. If used without a proper strategy and simply as a greed tool in an attempt to enrich yourself suddenly, the results can be really damaging.
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