What is Leverage in Forex?

In the lesson about Forex pips we learned that individual pips are generally of very low value. In order to take advantage of the pips we make as fx traders it is necessary to buy and sell large amounts of currency – a standard Forex lot of USD for example is $100,000. Most traders do not have this kind of money to trade with, so they use the power of leverage to help them out. Forex Leverage basically allows a trader to open a position for an amount greater than the total margin they have in their account. Margin is just a name for the available trading funds which have been deposited. Here is how it works.

If you are going to use $5000 of your account margin and you wish to open a position which is $100,000 in size, your account leverage is 20:1. This is because your position size is 20 times that of your margin. If the trader uses only $2000 margin then to open the same $100,000 position would require Forex trading leverage of 50:1, pretty simple so far.

Ok, so if you are only putting up a small percentage of the funds required open these large positions, where does the rest come from? Well, it comes from your broker. One of the roles of a broker is to facilitate Forex leverage by lending traders the additional funds they need to make a trade. If you are contributing only $2000 or $5000 of a $100,000 position, the other $98,000 or $95,000 is loaned to you by your FX broker. The trader themselves is always required to contribute at least a small amount of the position size, kind of like a deposit.

The amount of FX leverage you are allowed to use with your account will let you know how much you need to contribute to your position sizes. For example . . .

10:1 = 10% contribution

20:1 = 5% contribution

50:1 = 2% contribution

100:1 = 1% contribution

It is worth mentioning here that with Forex trading you do not have to use all of your available funds to make up the margin requirement when opening a position. So, if you have $10,000 in your account and you want to open a $200,000 position, if your account allows 100:1 leverage then you will only need to contribute $2000, which is 1% of your position size. Even though you are only offering up a small portion of the sum you are trading yourself, when the trade is live, the full amount gained or lost in pips will affect your account. So in this example you would have a pip value of $20, winning 10 pips would net you $200, whereas losing 10 pips would result in $200 being deducted from your account balance.