What is leverage in forex?
Leverage is a technique which enables traders to 'borrow' capital in order to gain a larger exposure to a particular market, with a comparatively small deposit.
It offers the potential for traders to magnify potential profits, as well as losses.
The forex market offers some of the lowest margin rates (and therefore highest leverage) compared to other leveraged assets, making it an attractive proposition to traders who like to trade using leverage.
Forex leverage explained
Leveraged trading, which is also known as trading on margin, means you can magnify profits if markets move in your favour; however you can also lose all of your capital should markets move against you. This is because profits and losses are based on the full value of the trade, and not just the deposit amount.
Forex is traded on margin, with margin rates as low as 3.3%. A margin rate of 3.3% can also be referred to as a leverage rate of 30:1 (leverage is commonly expressed as a ratio). This means you can open a position worth up to 30 times more than the deposit required to open the trade. The leverage ratio used for forex vs stocks, for example, is much higher. Stock market leverage start at around 5:1, which makes trading slightly less prone to capital risk.
What is margin in forex?
Margin is the amount of money needed to open a leveraged trade. When trading forex on margin you only need to pay a percentage of the full value of the position, which acts as a deposit. Margin requirements can differ between brokers, but start at around 3.3% for the most popular currency pairs.
Margin trading can be a double-edged sword however, as although it can increase your profits, it also can increase losses as both profits and losses are based on the full value of the trade.
Learn more about margin in forex trading.
Forex margin calculator
A forex margin calculator helps traders determine how much capital they need to open a new position, as well as manage their trades. It also helps them avoid margin calls by determining the optimal position size. In order to calculate the amount of margin needed, the trader would enter the currency pair, the trade currency, the trade size in units and the leverage into the calculator.
Margin call vs margin level
Any deposits used to keep positions open are held by the broker and referred to as ‘used margin’. Any available funds to open further positions are referred to as ‘available equity’ and when expressed as a percentage, ‘margin level’.
A margin call occurs when your margin level has dropped below a pre-determined value, where you are at risk of your positions being liquidated.
Margin calls should be avoided as they will lock in any of the trader’s losses, hence the margin level needs to be continuously monitored. Traders can also reduce the chance of margin calls by implementing risk-management techniques.
Forex trading risks
As much as leverage trading can be seen as a way to increase your profit, it also magnifies your risk. For that reason, having a good risk-management strategy in place is essential for forex traders using leverage. Brokers usually provide key risk management tools such as stop-loss orders, which can help traders to manage risk more effectively.
Stop-loss order
A stop-loss order aims to limit your losses in an unfavourable market by closing you out of a trade that moves against you at a price, specified by the trader. However, even if a stop-loss is in place, the close out price cannot be guaranteed due to slippage. You are essentially specifying the amount you are willing to risk on the trade. Learn more about stop-loss orders and how to use them.
Trailing stop-loss
A trailing stop-loss works similarly to a regular stop-loss, in that it aims to limit your losses when the market moves against you. However, with a trailing stop-loss, when the market moves in your favour, the stop-loss moves with it, aiming to secure any favourable movement in price. Find out more about trailing stops.
Take-profit order
A take-profit order works in the same way as a limit order, in that it’s always executed at the target price you specify. Where the market for any product opens at a more favourable price than your target price, your order will be executed at the better level, passing on any positive slippage.
Guaranteed stop-loss
Guaranteed stop-loss orders (GSLOs) work in a similar way to stop-loss orders, with the main difference being that a GSLO will be executed at the exact price you want, regardless of market volatility or gapping. For this benefit, there is a premium payable on execution of your order, which is displayed on the order ticket. The premium is refunded if the GSLO is not triggered. Find out more about guaranteed stop-loss orders.
See how you can set up various order types and execution alerts with our Next Generation platform.
And to learn more about Forex and how to trade it, visit our Forex trading page.
Summary
While margin is the deposit amount required to open a trade, leverage is capital borrowed from the broker in order to gain exposure to larger trading positions. Therefore, forex trading on margin enables traders to open larger positions with relatively small deposits.
It’s important to remember that trading on leverage can be risky as losses, as well as profits, are amplified.
Learn more about forex trading and its fundamental components in our forex trading for beginners guide.
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Disclaimer
CMC Markets is an execution-only service provider. The material (whether or not it states any opinions) is for general information purposes only, and does not take into account your personal circumstances or objectives. Nothing in this material is (or should be considered to be) financial, investment or other advice on which reliance should be placed. No opinion given in the material constitutes a recommendation by CMC Markets or the author that any particular investment, security, transaction or investment strategy is suitable for any specific person.
CMC Markets does not endorse or offer opinion on the trading strategies used by the author. Their trading strategies do not guarantee any return and CMC Markets shall not be held responsible for any loss that you may incur, either directly or indirectly, arising from any investment based on any information contained herein.