Forex leverage pdf

What is Leverage – Forex Leverage.

Nowadays each individual has access to Foreign Exchange market due to margin trading which is referred to speculation on the market by credit or leverage, provided by the broker for a certain amount of capital (margin) that is required for maintaining trading positions.

What is Leverage in Forex.

Leverage is the ratio of the client's funds to the size of the broker's credit. Usually, the size of leverage exceeds the invested capital for several times.

The size of Forex leverage is not fixed in all companies, it depends on trading conditions, provided by a certain company. IFC Markets offers leverage from 1:1 to 1:400. Usually in Forex market 1:100 is the most optimal leverage for trading. For example, if $1000 is invested and the leverage is equal to 1:100, the total amount available for trading will equal to $100.000. More precisely saying due to leverage traders are able to trade higher volumes. Investors, having small capitals prefer trading on margin (in other words using leverage), since their deposit is not enough for opening sufficient trading positions.

As it was mentioned above, the most popular leverage in Foreign Exchange market is 1:100, because high leverage, besides being attractive is very risky, too. Leverage in Forex may cause really big issues to those traders that are newcomers to online trading and just want to use big leverages, expecting to make large profits, while neglecting the fact that the experienced losses are going to be huge as well.

However, it is quite possible to avoid negative effects of Forex leverage on trading results. It is not rational to trade the whole balance, i. e. to open a position with the maximum trading volume. Another important technique is to use Stop Loss order, which will reduce the possible risks.

Forex Leverage Example.

Example How Leverage is Used in Forex Trading.

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What are Forex Pips, Lots, Margin and Leverage.

Knowing and understanding the proper terminology within the forex market is essential in becoming a successful trader. In this article we discuss and define what pips, lots, margin and leverage are. We also provide examples of each for easier comprehension.

Pips and Lots.

Currency traders quote the value of a currency pair, and trade sizes, in pips and lots. A pip is usually the smallest amount by which the value of a currency pair can change, although these days some brokers offer fractional pip quotes too. In example, when the value of the EUR/USD pair goes up by one tick (i. e. pip) the quote will move from 1.2345, to 1.2346, and the size of the movement is just one pip. An important guideline for the beginning trader is to measure success or loss in an account by pips instead of the actual dollar value. A one pip gain in a $10 account, is equal, in terms of the trader’s skill, to a 1 pip gain in a $1,000 account, although the actual dollar amount is very different.

The smallest size in currency trading for professional traders is called a lot. For USD-based pairs, the lot size is 100,000. In other words, when you enter a trade with your margin account, the smallest amount that you can buy or sell is 100K, regardless of the size of your margin.

Margin and Leverage.

Another important concept in currency trading is the twin phenomenon of margin and leverage. This is a concept that carries a high degree of risk, but since forex prices move very slowly (in terms of the actual change in value), the vast majority of traders leverage their accounts when engaging in short-term trading.

When you open a forex account, the broker will request that you deposit a small sum, known as margin, as insurance against the losses that your account may suffer. With this small sum, you’re able to control a much larger amount, enabling greater gains, but also greater losses than you would be able to achieve with your deposit. It’s easier to understand margin and leverage in the context of a borrowing process. The lots that you can trade are borrowed from your broker, who requires a margin deposit as an insurance against losses. The ratio between the funds borrowed by you, and the margin that you deposit as insurance is called leverage. Thus, if you set a leverage ratio of 100:1, enabling the trade of 1,000,000 USD with just 10,000 USD in deposit, but eventually trade just 100,000, the actual leverage that you would be using is 10:1. Note that leverage over 50:1 for majors and 20:1 for minors is not available to traders in the U. S.

In order to understand how to manage your account you must gain a good understanding of leverage. Failure to pay proper attention to leverage and margin may result in a margin call and the broker may liquidate your position in order to ensure that your losses do not reach a level where your margin deposit is insufficient to cover them. Increasing leverage = increases risk.

Forex leverage: How it works, why it's dangerous.

Currency traders around the world are still reeling from the effects of the Swiss National Bank's surprise move to ditch its efforts at pegging the value of Swiss francs to euros.

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For three years, the SNB had used its own war chest to make sure that a euro was worth 1.20 Swiss francs. After giving up on trying to artificially keep the euro strong and franc weak, the value of euros plummeted, thus wreaking havoc on global currency markets.

And it wasn't just large banks, hedge funds and corporations that felt the pain but also smaller traders and investors, as well.

Over the past decade or so, the world of foreign exchange trading has seen the emergence of brokerages that cater to retail, or smaller traders. While the accessibility to global currency markets had been reserved for just professionals, or larger institutions, retail forex brokerages allowed up-and-coming traders with limited financial resources to participate in the market.

However, the risks that kept the market "off limits" for the smaller folks came roaring back with a vengeance over the last couple of days.

The SNB's action to remove its currency peg pushed the value of euros relative to Swiss francs off a cliff, and allowed no real time for anyone to react, or manage trading risks in a traditional manner.

The economic impact, in terms of losses, is much greater from a corporate or institutional standpoint. However, many retail traders found their trading accounts completely wiped out, being on the wrong side of a trade that couldn't be liquidated fast enough to preserve their capital. Trading in currency markets at the retail level, with these types of brokerages, centers on the use of one of the biggest double-edged swords in financial markets: leverage.

In other words, borrowed funds that are used to amplify potential returns but can also exacerbate the potential losses of trading positions. In the world of retail foreign exchange trading, use of leverage is key.

Here's how it works:

Let's say you want to take a $10,000 position in terms of Swiss francs. Under current regulatory guidelines in the U. S., you are mandated to keep at least $200 in your account in order to support that position. That's because there's a mandated minimum margin requirement of 2 percent for retail forex markets.

In other words, you can only have a position that's 50 times greater than the equity in your margin account.

If the value of your position grows because of market movements, there is no issue. But if your position loses value to a point where you no longer meet minimum margin requirements, your broker will liquidate assets to help assure that you don't lose more money than you put into the account.

The reason why some retail foreign exchange brokerages have gone bankrupt, and others are in severe distress, has to do with how those margin accounts were maintained during the SNB's shock move. Certain accounts with losing positions weren't able to be liquidated quickly enough before they went into deficit. That left some brokers responsible for the debit balances in client margin accounts. If those debit balances were high enough, that could cripple the capital position of these retail brokerages.

At that point, a handful of things can happen.

For one, the broker can request the client to add enough funds to bring their account back into good standing. Or, the broker is left holding the bag on client losses, perhaps with only legal recourse to try to recover those losses.

According to Forex, which is a retail foreign exchange broker and is owned by publicly traded Gain Capital, the company does "reserve the right to hold clients responsible for large debit balances and in special circumstances." Its website also encourages clients to manage use of leverage carefully, since use of more leverage increases risk.

Bottom line, the pain of the SNB's removal of its currency peg hit numerous parts of the market, and will lead to outsized financial losses for the big guys and the little guys. On a relative basis, retail traders may feel more pain than their bigger counterparts.

The recent market action serves as a potent reminder of just how dangerous leverage can be when price action moves swiftly, and without warning.

How does leverage work in the forex market?

The concept of leverage is used by both investors and companies. Investors use leverage to significantly increase the returns that can be provided on an investment. They lever their investments by using various instruments that include options, futures, and margin accounts. Companies can use leverage to finance their assets. In other words, instead of issuing stock to raise capital, companies can use debt financing to invest in business operations in an attempt to increase shareholder value. (For more insight, see What do people mean when they say that debt is a relatively cheaper form of finance than equity? )

In forex, investors use leverage to profit from the fluctuations in exchange rates between two different countries. The leverage that is achievable in the forex market is one of the highest that investors can obtain. Leverage is a loan that is provided to an investor by the broker that is handling the investor's or trader's forex account. When a trader decides to trade in the forex market, he or she must first open a margin account with a forex broker. Usually, the amount of leverage provided is either 50:1, 100:1 or 200:1, depending on the broker and the size of the position that the investor is trading. what does this mean? A 50:1 leverage ratio means that the minimum margin requirement for the trader is 1/50 = 2%. A 100:1 ratio means that the trader is required to have at least 1/100 = 1% of the total value of trade available as cash in the trading account, and so on. Standard trading is done on 100,000 units 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.

[When using leverage, it's important to use risk management techniques to limit losses. Many forms of risk management fall under the technical analysis umbrella. For example, stop-loss points may be set near support or resistance levels. Investopedia's Technical Analysis Course provides an in-depth overview of these concepts and others to help you become a successful trader.]

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 on equities and the 15:1 leverage provided in 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% during intraday trading. If currencies fluctuated as much as equities, brokers would not be able to provide as much leverage.

Although the ability to earn significant profits by using leverage is substantial, leverage can also work against investors. For example, if the currency underlying one of your trades moves in the opposite direction of what you believed would happen, leverage will greatly amplify the potential losses. To avoid such a catastrophe, forex traders usually implement a strict trading style that includes the use of stop and limit orders.