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What is Leverage in Forex Trading
Written by: PaxForex analytics dept - Friday, 07 April 2017 0 comments
Forex trading by retail investors has grown by leaps and bounds in recent years, thanks to the proliferation of online trading platforms and the availability of cheap credit. Leverage is defined as the use of borrowed capital, such as “margin” allowing the trader to gain access to larger sums of capital. Specific to forex trading, it means you can have a small amount of capital in your account controlling a larger amount in the market.
The concept of leverage is used by both investors and companies. Investors use leverage to significantly increase the returns that can be provided on an investment. They lever their investments by using various instruments that include options, futures and margin accounts. Companies can use leverage to finance their assets. In other words, instead of issuing stock to raise capital, companies can use debt financing to invest in business operations in an attempt to increase shareholder value.
In forex, investors use leverage to profit from the fluctuations in exchange rates between two different countries. The leverage that is achievable in the forex market is one of the highest that investors can obtain. Leverage is a loan that is provided to an investor by the broker that is handling his or her forex
account. When an investor decides to invest in the forex market, he or she must first open up a margin account with a broker. Usually, the amount of leverage provided is either 50:1, 100:1 or 200:1, depending on the broker and the size of the position the investor is trading.
It is important to note that leverage is often considered a double-edged sword since large price swings on accounts with higher leverage increase the chances of triggering your stop loss. Because of that, most beginner traders might prefer to start off using minimal leverage to get an idea of how to use proper risk management in order to minimize losses. More experienced traders may use higher-leverage accounts to maximize their wins and benefit from that advantages that forex has over other financial markets.
Unlike futures and stock brokers that offer no or tiny leverage, the offers from forex brokers are much more attractive for traders that are looking to enjoy the maximum gearing size. It is hard to indicate the size of the leverage one should look for, yet most of the forex broker leverages available would start at 100:1 and average at 200:1. There are many brokers that can supply 500:1 leverage. Also, in very rare cases it is possible to open an account with a broker that supplies 1,000:1 - however, there aren't many traders who would actually want to use gearing at this level.