For all of us who are trading forex it is important to understand what leverage is and how it can perform for us during the trading process. One of the biggest reasons why the forex market is exciting and accessible to small retail traders is because of the industry’s high leverage options. Leverage gives a trader the ability to increase the potential return on an investment but also it increases the potential risk.
Leverage is the ability to convert a small amount of power into a larger amount through the use of a tool. You can make money by investing just your own money, but you can make much more money if you can use the tool of financial leverage by borrowing money from your forex broker. This means you can lever or increase the investing power of your forex account by using some of your own money to enter a trade and then essentially borrowing the rest from your broker.
For example, if you have 1:100 leverage in the forex market you can control $100,000 with as little as $1,000 of your own money. That means you only have to pay for 1 percent of the position with your own money. You can borrow the remaining 99 percent of the purchase price from your forex broker. This doesn’t mean that your profits are going to get increased just because of the leverage offer.
It can go both ways depending on your trading strategy. The leverage you enjoy in the forex market is determined by what your broker is able to offer you and your own preference. When you trade with leverage you need to always be aware of margin requirements. Margin is the money you set aside with your forex broker for safe keeping to prove that you are able to cover your losses. Different currencypairs have different margin requirements.
If the market moves against a trader resulting in losses such that the trader lacks a sufficient amount of margin there is an automatic margin call. This means your forex broker will close the trade before the account balance turns negative. This will prevent your forex broker of losing any money and it means that you are going to lose only your money.