Forex Walkthrough

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Level 2 Markets - Leverage

So we've explained the basic steps you need to take to get started in the forex market, now let's take a closer look at leverage and its role in the market.



The leverage that is achievable in the forex market is one of the highest that individual investors can obtain. Leverage is a loan that is provided to an investor by the broker that is handling his or her forex account. Usually, the amount of leverage provided is either 50:1, 100:1 or 200:1, meaning your broker will allow you to trade up to 200 times the amount of actual cash you wish to trade. Leverage amounts vary depending on your broker and the size of the position you are trading. Standard trading is done on 100,000 units (ie. dollars) of currency, so for a trade of this size, the leverage provided is usually 50:1 or 100:1. Leverage of 200:1 is usually used for positions of $50,000 or less.

To trade $100,000 of currency with a margin of 1%, an investor will only have to deposit $1,000 into his or her margin account. The leverage provided on a trade like this is 100:1. Leverage of this size is significantly larger than the 2:1 leverage commonly provided in the stock market and the 15:1 leverage provided by the futures market. Although 100:1 leverage may seem extremely risky, the risk is significantly less when you consider that currency prices usually change by less than 1% over the course of a day. If currencies fluctuated as much as stocks, brokers would not be willing to provide such large leverage amounts.

Although the ability to earn significant profits by using leverage is substantial, leverage can also work against you. For example, if the currency behind one of your trades moves in the opposite direction of what you believed would happen, leverage will greatly amplify the losses. To avoid such losses, experienced forex traders usually implement a strict trading style that includes the use of stop and limit orders (both of which we will discuss in depth later in our walkthrough). Now that we've learned about leverage and the role it plays in the forex market, let's take look at some of the other risks associated with forex. (To learn more, see Forex Leverage: A Double-Edged Sword.)


The Risks


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RELATED TERMS
  1. Maximum Leverage

    The maximum size of a trading position permitted through a leveraged ...
  2. Leverage

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  3. Degree Of Combined Leverage - DCL

    A leverage ratio that summarizes the combined effect the degree ...
  4. Leverage Build Up

    The accumulation of additional debt to enter a position that ...
  5. Leveraged Loan

    Loans extended to companies or individuals that already have ...
  6. Degree Of Operating Leverage - ...

    A type of leverage ratio summarizing the effect a particular ...
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  2. What are the risks of having both high operating leverage and high financial leverage?

    In finance, the term leverage arises often. Both investors and companies employ leverage to generate greater returns on their ... Read Answer >>
  3. Besides operating leverage, what are other important forms of leverage for businesses?

    Learn about what other forms of leverage exist for businesses besides operational leverage, and the primary leverage metrics ... Read Answer >>
  4. Can mutual funds use leverage?

    Learn about what types of mutual funds use leverage, how leverage can increase returns and what restrictions are in place ... Read Answer >>
  5. What is the difference between operating leverage and financial leverage?

    Discover the two equity valuation metrics, operating leverage and financial leverage, how they are similar and what differentiates ... Read Answer >>
  6. What is the difference between leverage and margin?

    In financial terms, leverage is reinvesting debt in an effort to earn greater return than the cost of interest. When a firm ... Read Answer >>

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