Leverage is the ratio between the amount of money you deposited and the amount of money you can trade. Additional money (leverage) is provided by your broker.
Leverage increases your trading power allowing you open positions larger than you could open having only your private funds. The ratio can be reflected in “X:1” format.
Let’s see how it works on the example. You invested $10,000 supplying the sum by yourself. This is 1:1 leverage (in essence, this is an unleveraged position), as you don’t borrow anything from the broker. If you earn $100, your return will be 1% ($100/$10,000*100). At the same time, if you lose $100, your loss will be just -1% return as well.
Imagine that you don’t have $10,000, but want to trade this amount. Forex trading allows you to do that with the help of leverage. In this case, your broker will require 1% margin equal to $100 on your account. This is your used margin. The leverage is 100:1 because you control $10,000 with just $100. The remaining 99% is provided by the broker. The margin is needed for broker’s security in case the market goes against your position. In the case of $100 profit, your return will be 100% ($100/$100*100). However, if you lose $100, it the return will be -100%. As you can see, with leverage small movements of the currency pairs can result in larger profits or larger losses when compared to an unleveraged position.
2020-07-24 • Updated