So I went over on how to choose your trading accounts wisely. Basically what leverage means is borrowing money to control a very large amount of money you don’t owe. You can control $200,000 with a $1,000 deposit, also known as 200:1 ratio. Leverage is about risk. Increasing your leverage increases both your opportunity to take bigger profits and rack up bigger losses. Here is a quick example
Example:
* A trader has $1.000 in his account.
* He buys one lot ($100,000) of GBP/USD at the price of 1.9750 with the maximum 200:1 leverage. The margin used is $500.
* If the market moves in the trader’s favor up to 1.9850 (a 100-pip move), he makes a profit of $1,000 (100 pips x $10 per pip). His capital is now double his initial account capital ($1,000 initial capital + $1,000 gain). He made a 200% gain on his $500 margin and a $100% return on his $1,000 account.
* If the market moves against the trader’s position by 20 pips, down to 1.9730, the trader loses $200 (20 pips x $10 per pip). His capital is now down to $800 ($1,000 – $200).
* If the market moves against the trader’s position, let’s say 60 pips down to 1.9690, his position would have been automatically closed due to what is known as margin call. This means that the moment his account capital dropped below the $500 margin requirement, the position closes to avoid bigger losses. In this case, the trader has lost around $500, or 50% of his initial equity. He still holds $500 in his account.
I also need to go over margin. Let’s go back to where I said “You can control $200,000 with a $1,000 deposit, also known as 200:1 ratio.” That $1,000 you put down is your “margin” and that’s what you had to give in order to use leverage. You need margin so your broker can hold your position. The broker takes your $1,000 deposit and throws them with everyone else’s margin deposits, and uses this super margin deposit to be able to place trades with the interbanks. Some brokers will say that they require a .25%, 1% or 2% margin. This is how margin is expressed. It’s expressed as a percentage of the full amount of the position. Here’s a quick chart on what some brokers offer
Margin Required Maximum Leverage 5% 20:1 3% 33:1 2% 50:1 1% 100:1 .5% 200:1 .25% 400:1
If you want to play the leverage on forex game, understand how the game works. The game basically works this way: The broker is the shark. The retail trader is shark food. If you are serious in your quest to make money currency trading – educate yourself.
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