What Is Leverage In Forex? How To Calculate Forex Leverage (With Example)?
Forex leverage is one of the reasons why people are interested to trade currency compared to other financial investments. leverage plays a vital role in forex trading.
In our previous article, we have already discussed the differences between leverage and margin. Leverage is so important that we feel the need to discuss this term broadly with some examples.
Before coming to the exact point, let us see how many accounts are available in Forex trading. In the Forex market, traders deal with two types of accounts:
- Cash account
- Margin account
Additionally, people consider a cash account as a normal account. Especially, day traders prefer 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 is allowing debt. Traders can invest extra dollar with the help of the broker and get extra profit from that account.
Through this article, you will able to know the definition of leverage, how to calculate leverage and many other important facts.
What Is Forex Leverage
What is leverage in Forex?
Eventually, leverage means to borrow money for investing. Similarly, forex leverage means controlling a large amount of money in Forex trading by borrowing from brokers.
Traders are investing none or a small amount of money to open a position. Leverage is all about the ratio. Brokers are helping traders by giving leverage on their margin account. 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. You are controlling $10,000 with $100. Your leverage is 100:1.
So, you can express leverage as a ratio. Remember that it is the ratio between the amount of money you have and the amount of money you can trade with.
Higher leverage can increase your potential profit amount. The downside is that leverage can also give you a huge loss.
The ideal amount of leverage is .5 or less than this. Leverage calculation is important if you want to set effective leverage on your trading account.
Depending on your account types and risk preference, you can open a much smaller or higher trade position.
Remember, the use of leverage for making more money is not the primary goal. It is a tool that you can use to manage your trading risk effectively.
Another key point is when a broker allows you to open a maximum size of the tradeable position is known as maximum leverage.
How To Calculate True Leverage
To find out the true leverage, traders have to divide the full amount of their position by the amount which has already deposited in their trading account.
On the other hand, true leverage fluctuates time to time, depending on the market situation.
The formula for calculating the true leverage is:
The full amount of position/Deposited amount
Suppose you have $10,000 in your trading account. To open a USD/CAD position, here you are selecting 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. So, the true leverage is 10:1.
Moreover, you will find some online application which will help you to calculate your true leverage.
How To Calculate An Effective Leverage
Leverage helps traders to open a large 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 in the trading market, it is necessary to check the appropriate leverage ratio.
On the other hand, a few brokers allow traders to trade with high leverage. 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, and he has already opened two positions in the trading market.
$50,000 long on EUR/USD
$10,000 short on USD/CAD
As the trader has opened two positions so, his total position is 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 use a forex leverage calculator. You don’t need to pay for it.
Leverage calculator will allow calculating the total amount of buying power based on your capital or initial investment.
However, different leverage calculator will allow you to input different information.
As I have noted above, you can also calculate your true leverage through an online leverage calculator. It is also possible to find out leverage ratio.
Leverage Amount In Forex Trading With Example
Leverage amount varies brokers to brokers. The amount depends on the margin like how much you want to trade.
Forex brokers also give leverage depends on their rules and regulation. The maximum amount is depending on the broker’s choice.
On the other hand, there are also some margin requirements depending on the currency you want to trade.
Brokers also change margin rules when they want to change. This 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
Ten to one leverage means that for every $1, you can open a position or place a trade of $10.
If your deposited amount is $100, you will be able to trade up to $1,000. This ratio is 10:1 leverage. It is not necessary to trade $1000 but this ration indicates that you will able to trade up to $1,000.
Fifty to one leverage means that every $1 in your account, you can open a position worth of $50.
If you deposited amount is $2000, you will be able to trade up to $10, 0000.
The calculation is the same for each leverage ratio. The output will depend on the margin amount.
Is It Good For Traders?
The right amount totally depends on your trading skills and strategy, although it is hard to determine the right amount of leverage for your trading
Smaller leverage will lead you to open a trading position for a long time. Due to the market fluctuation, sometimes the margin amount changes a bit.
If you are a day trader, then you can easily trade with low leverage or no leverage.
Here, we can see this, there is a relationship between the Forex and the Leverage.
Your big size of leverage will help you to move your margin amount. The fluctuation ratio is quicker than normal times.
At the same time, leverage will give you the opportunity to trade with positions of high value. If you really don’t feel this is necessary to use leverage, then my suggestion is to avoid that.
It is important to set your trading strategy before applying for the leverage. Moreover, the pip value does not vary based on the leverage.
Leverage And Trader’s Choice
In the final analysis, the leverage amount depends on the trader’s choice, and also on the trading strategy.
Those who are professional trader always prefer low leverage. Lower leverage will protect your capital from draining out.
Low leverage like 10:1, 20:1 is the amount preferred by the professional traders.
We actually encourage traders to go fora low leverage. Low leverage will help you to control your equity loss.
Your equity will remain higher if you use lower leverage. 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. In the first place, it is necessary to pick the right leverage level. A higher amount of leverage can wipe out his account from Forex.
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.
Limit your trading risk. It is better not to take risk more than 2%.
The brokers are taking spread to earn their bread and butter. When a trader is taking high leverage, then a broker is earning more. So before taking leverage from any broker, just take your decision wisely.
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 precaution to protect your capital. It is not necessary to accept high leverage from traders as they are offering.
On the other hand, it is a liability of traders which you have to meet at the end of the day.
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.
Here the margin totally depends on the leverage to open a new position. So it is better to trade with limited leverage.