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Forex Leveraging: the basis

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Leverage the investment size increase of by using credit from a broker, so it means that you are actually borrowing from your broker. These resources are your account’s margin. Margin determines the amount of leverage and is mostly applied as a percentage, whereas leverage as a ratio.

For instance when a broker requires a minimum margin level of 3%, the customer must have at least 3% of the total value in cash before opening the position. A 3% margin requirement is equivalent to a 33:1 leverage ratio, which means that having $1,000 in your account would allow you to trade up to $33,33. Leverage also varies according to different aspects such as the market and the country you are trading.

High leverage availability and a low opening an account minimum balance have attracted the forex market to retail traders. On the other hand, unnecessary use of leverage is a reason why traders fail with forex. In August 2010, the Commodity Futures Trading Commission (CFTC) limited leverage available to retail forex traders to 50:1 on major currency pairs and 20:1 for all others by releasing rules for retail foreign exchange transactions.

For example, to trade a standard $100K lot you would need to have margin of $1K in your account. If you make a trade to buy 1 standard lot of USD/CAD at 1.0310 and price moves up 1% (103 pips) to 1.0413 your account would increase by 100%. On  the contrary, a 1% fall with 100K lot would affect a 100% loss.

If you are trading with 50:1 leverage and 1 standard $100K lot you would need a margin of $2K (2% of 100K).




This means that if you buy 1 standard lot of USD/CAD at 1.0310 and price rises to 1% to 1.0413, you would see a 50% boost in your account, while a 1% fall with a standard 100K lot would equal a 50% loss.

When 1% moves are very likely to happen, particularly when huge economic releases happen. Only a couple of losing trades combined with the leverage as described above can bring a total disaster. There is a narrow line between the possibility of succeeding or losing it all, and this is proved by the fact that successful traders frequently suffer numerous losing trades but are still trading as they are accurately capitalized and not overleveraged.

With the lower leverage of 5:1, when you trade for example a standard $100K lot you would require margin of $20K. An unfavorable 1% change would generate a  much more convenient loss of 5%.

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Traders can use lower leverage levels (Micro lots) enable such as 5:1 with smaller accounts. A micro lot is equal to an agreement of 1,000 units of the base currency and allocate flexibility and chance for traders to trade with lower leverage.

Once you have entered a trade, your account's Net Asset Value (NAV) is checked by your broker. In the case where your account assessment falls beneath the minimum margin, you may receive a margin call. You would be asked to add money to your account, or your broker flattens your positions so as to avoid further losses. Nevertheless you should keep the degree of risk low, less than 1-2%.

 

Concluding, it should be denoted that leverage is beneficial, contributing to flexibility and effectiveness, and of course generating opportunities.

See all 8 articles in category Forex

 
 
 
 
 
 
 
 

 
 

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