Leverage

One of the main advantages to trading in the foreign exchange market is leverage. After reading the previous chapter you may be thinking, I need to have 100,000 Euro in order to make $10 a pip?!?

That doesn’t seem to be worth the effort. But here is one of the big differences between the Forex and other financial markets, and in one word that’s leverage.

Leverage is sometimes known as a margin account, and these are very common in the foreign exchange market. So what is leverage? Leverage is the ability to trade in amounts that are higher than your total deposit held. For instance you may have a deposit of $5,000 and be allowed to trade in amounts of $500,000!

With Forex Place the leverage offered is 300:1, which means that you are able to trade up to 300 times your equity value. You may now be asking yourself how this is possible; nothing is for free these days; well you would be right. The greater the leverage used by the trader the greater his earning ability but also the greater his risk. This is a two edged sword. The initial deposit placed by the trader is used as collateral against the position held.   It should be noted that traders do not have to use the leverage offered by the broker, they can use none of it part of it or all of it; the decision is totally up to the trader.

Let’s do another example:   Say a trader deposited $10,000 with Forex Place, (as mentioned before we offer a leverage of 300:1), for ease lets use an example of a 100:1 leverage; in this case the trader can hold trades up to 100 times that of his deposit, which in this case would be $1,000,000.   If the trader believed that the US Dollar is going to fall against the Japanese Yen he would be looking at selling the USD/JPY or trading at the Bid. Let’s look at the rates given earlier:

Instrument Bid Ask
USD/JPY 123.40 123.43

The trader would sell the USD at 123.40; the question is in what amount? Before we answer that lets assume that the market moved 50 pips in favor of the trader.   Lets now take two different scenario’s one where the trader used no leverage and the second with.

Scenario 1: No leverage used

The trader Sold 10,000 USD/JPY at 123.40 and closed the trade at the Ask price was the market showed 122.90 for the Bid and 122.93 for the Ask.

The trader now buys 10,000 USD/JPY at 122.93.

What is the trader’s profit?

123.40-122.93=47 pips or 0.47 10,000*0.47= 4,700 JPY 4,700/122.93= 38.23 USD

Scenario 2: 100:1 leverage used

The trader Sold 1,000,000 USD/JPY at 123.40 and closed the trade at the Ask price was the market showed 122.90 for the Bid and 122.93 for the Ask.

The trader now buys 1,000,000 USD/JPY at 122.93.

What is the trader’s profit?

123.40-122.93=47 pips or 0.47 1,000,000*0.47= 470,000 JPY 470,000/122.93= 3,823 USD

As can be seen in scenario 1, the trader made a profit of 38.23 USD which is a return of 38.23/10,000*100 = 0.38% which is not bad on one trade; however as can be seen in scenario 2, the trader made a profit of 3,823 USD which is a return of 3,823/10,000*100 = 38%!

From this we can see that if a client uses 100:1 leverage and trades on the full amount possible, if the market moves in his favor he will double his money; however if the market moves against him by 1% on a maximum leverage of 100:1, the trader will be left without a deposit. As can be seen leverage is a great tool, but should be used wisely.

When discussing leverage one other point should also be noted, and that is the minimum trade size. Here is another big advantage to choosing Forex Place since all accounts at Forex Place have a minimum transaction size of 10,000 of the base currency.   If a trader deposits $5,000 with Forex Placer and the minimum tradable amount is 10,000, he will have to use some sort of leverage.

If he trades in 10,000 amounts he will use a leverage of 2:1 that means that the price must move by 50% (which is a huge move in the Forex market) for the trader to either double his money if the market move is in his favor or lose his funds if the market move is against him.

However if the trader uses the full leverage amount and trades in amounts of 500,000 then as stated above a 1% move in either direction (which is not that large in the Forex market) will be sufficient to have the same results as mentioned above.