To trade in the forex markets, most traders use leverage. This means that you only need to deposit a small percentage of the full amount of a currency that you wish to trade with, and the rest is loaned to you by your broker. If your broker allows you to use leverage then your potential profits or losses for your initial capital outlay may be significantly increased.
An example of using leverage with money borrowed from your broker would be as follows:
Because leverage increases your potential for losses as well as profits, it is important that you always use sound risk management techniques when trading in this way. Forex brokers typically offer anything from 50:1 leverage, up to 1000:1 leverage (compare this with the far lower 2:1 leverage that is available from US stock brokers), but just because the leverage is offered does not mean that you have to use it. For instance, if the forex trader in our example above was extremely risk averse, then he or she might choose to buy only $2000 worth of Euros, thereby using absolutely no leverage whatsoever.
An example of using leverage with money borrowed from your broker would be as follows:
- You have $2000 in your forex brokerage account.
- You choose to trade with 50:1 leverage, which means that for every $1 in your account you are able to trade with $50 (borrowing $49 from your broker).
- You are able to buy 2000 x 50 = $100,000 of another currency such as the Euro.
Because leverage increases your potential for losses as well as profits, it is important that you always use sound risk management techniques when trading in this way. Forex brokers typically offer anything from 50:1 leverage, up to 1000:1 leverage (compare this with the far lower 2:1 leverage that is available from US stock brokers), but just because the leverage is offered does not mean that you have to use it. For instance, if the forex trader in our example above was extremely risk averse, then he or she might choose to buy only $2000 worth of Euros, thereby using absolutely no leverage whatsoever.