What Is Leverage In Forex? How To Calculate Forex Leverage With Example?
Forex leverage is one of the reasons why people are interested in trade currency compared to other financial investments. Leverage plays a vital role in forex trading.
In our previous article, we have already explained the differences between leverage and margin. But we feel the need to discuss the term leverage vastly with examples.
Before coming to the exact point, let’s see how many accounts are available in Forex trading. In the Forex market, traders deal with two types of accounts:
- Cash account
- Margin account
People consider a cash account as a normal account. Additionally, day traders prefer to execute trades through a normal account. You can trade with an equivalent amount that you have deposited on your account. Also, you can buy or sell currency from the cash account.
On the other hand, the margin account allows for debt. So, traders can invest extra dollar with the help of the broker and can get extra profit from that account.
Through this article, you will able to know the definition of forex leverage, forex leverage calculator, how to calculate, and other important facts.
What Is Forex Leverage
Leverage means to borrow money. Similarly, forex leverage means controlling a large amount of money in currency trading by borrowing from brokers. To open a position, traders invest none or a small amount of money. By using leverage, you will add power to your initial capital.
For example, to control a $10,000 position, your broker will set aside $100 from your account. So, you are controlling $10,000 with $100, and the ratio is 100:1.
It is the ratio between your account balance and the trade amount. Higher leverage can increase your profit potentiality. However, it can also give you a huge loss if you can’t apply it.
The ideal amount of leverage is .5 or less than this. Leverage calculation is important if you want to set effectively on your trading account.
Depending on account types and risk preference, a trader can open a smaller or higher trade position.
Remember, for making more money, usage of leverage is not the primary goal. It is a tool that you can use to manage your trading risk effectively.
On the other hand, in maximum leverage, brokers allow traders to open the largest size of a trading position
How To Calculate True Leverage
To find out the true leverage, you have to divide the full amount of position by the deposited amount. True leverage fluctuates time to time, depends on the market situation.
You can use a formula to calculate the true leverage:
The full amount of position/Deposited amount
Suppose you have $10,000 in your trading account. To open a USD/CAD position, you are willing to select the standard lot at the rate of $1.00.
The full value of your position is $100,000, and the balance of your account is $10,000. Here, the true leverage is 10:1.
Moreover, you will find some online application that will help you to calculate your true leverage.
How To Calculate An Effective Leverage
As we stated before, leverage helps traders to open a larger position in the Forex market. High leverage will help you to hold your trading position for a shorter time. Brokers have different margin requirements. Before investing money, it is necessary to check an appropriate leverage ratio.
Without leverage, traders will able to earn a very low percentage of profits like .3% to .5%. Moreover, you will find out an effective leverage ratio by using this following formula.
Effective Leverage Ratio = Total trading position size/ Total Equity.
Let us assume that a trader has $10,000 in his trading account. He has already opened two positions with two different asset pairs.
- $50,000 long on EUR/USD
- $10,000 short on USD/CAD
As the trader has opened two positions, so the total position worth $60,000.
The trader’s effective leverage is = $60,000/$10,000 = 6 times
Forex Leverage Calculator
If you want to calculate your leverage automatically, then using a forex leverage calculator is mandatory. You don’t need to pay for it.
Leverage calculator allows traders to calculate the total amount of buying power based on the capital or initial investment.
However, different leverage calculator will allow you to input different information.
Not only the leverage ratio but, you can also calculate your true leverage through an online leverage calculator.
Leverage Amount In Forex Trading With Example
Leverage amount varies broker to broker. The amount depends on the margin like how much you want to trade. Forex brokers also give leverage depending on their rules and regulation. The maximum amount depends on the broker’s choice.
On the other hand, some margin requirements depend on the currency you want to trade. Brokers also change margin rules when they want to change. However, the change depends on the market condition and market volatility.
Now, we are going to break down the leverage amount ratio one by one. Here, we only took two ratios as a forex leverage ratio example.
Leverage Amount of 10:1
Ten to one leverage means that for every $1, you can open a position or place a trade of $10.
Example:
If your deposit amount is $100, you will be able to trade up to $1,000. The ratio is 10:1 leverage. It is not necessary to trade $1000 but the ratio indicates that you will able to trade up to $1,000.
Leverage Amount of 50:1
Fifty to one leverage means that every $1 in your account, you can open a position worth of $50.
Example:
If your deposit amount is $2000, you will be able to trade up to $10, 0000. The calculation is the same for each leverage ratio. But the output will depend on the margin amount.
Is Leverage Good For Traders?
The right amount of leverage depends on your trading skills and strategy, though it is hard to determine. Smaller leverage will lead you to open a position for a long time.
Due to the market fluctuation, the margin amount changes a bit. A day trader can easily trade with low leverage or no leverage.
You can see there is a relationship between the Forex and the Leverage. The size of leverage will help you to move the margin amount. At the same time, the fluctuation ratio is quicker than normal times.
At the same time, leverage will allow you to trade with positions of high value. If you don’t feel leverage necessity, then my suggestion is to avoid that.
Furthermore, it is important to set your trading strategy before applying for leverage. Moreover, the pip value does not vary based on the leverage.
Leverage And Trader’s Choice
The leverage amount depends on the trader’s choice, and also on the trading strategy. Those who are professional always prefer low leverage. Low leverage will protect your capital from draining out.
We also encourage traders to go for a small amount of leverage. It will also help you to control your equity loss, and your equity will remain higher.
Furthermore, your trading risk will be minimized after using a minimum amount of leverage. As a beginner, it is wise to open position using a small amount of leverage.
Maintaining low leverage is equally important for traders to manage trading risk. Along with this, you can also use the trailing loss to reduce downside and protect capital.
Importance Of Forex Leverage
The major importance of leverage is that it will give an opportunity to open a larger trading position.
The size of the leverage varies, which I have mentioned above of this article.
Additionally, leverage determines the trading situation. Either the trade is risky or not. Forex leverage also increases your trading profitability if you can pick the right amount.
On the positive side, it is a very powerful trading tool for a new and experienced trader. Remember, it is your responsibility on how to use the leverage ratio.
How Does Leverage Affect Traders
Never underestimate the power of forex leverage.
You can lose your all money for using high leverage, although it is the only way to make money. Try to take precautions to protect your capital. It is not necessary to accept high leverage from brokers as they are offering.
On the other hand, it is a liability of traders that you have to meet at the end of the day.
Final Words
The bottom line is that leverage is usually known as the “Double Edge Sword”. It will cut you in two ways if you are not following the money market rule and the risk management rule.
The margin depends on the leverage to open a new position. So, it is better to trade with limited leverage.
