Forex online trading has many features that attract more potential investors compared to other financial market in the world, and leverage is one of them.
With forex you can usually get much higher leverage than with stocks, letting you earn more potential profits in relation with the amount you originally invested.
Leverage in forex online trading means the amount of money you are allowed to borrow from the broker when you open a position. Typically, when you buy 100 shares of a company trading at $10 per share in the stock market, you are required $1000 to open the trade.
Some stock brokers would let you borrow 50 to 80 percent of the total stock value, requiring only $500 to buy shares. Of course, the broker will charge interest for the loan.
On the other hand, forex leverage, as one experienced trader puts it, “is similar but on steroids”.
A typical forex broker will let you borrow 99 percent of the total value required to open a trade and you only need to come up with the remaining 1 percent while a forex broker will not charge you interest on the borrowed amount.
Also, in the case of stock trading you will be liable to pay up $500 (or more) you borrowed in case of a loss. In forex online trading, your broker will close out all open trades as soon as your account available balance reaches zero.
Let’s explain this with a practical example. If you are required to deposit 1 percent of the total transaction value as margin and you intend to trade one standard lot of USD/CHF, which is equivalent to US$100,000, the margin required would be US1,000. This way your margin-based leverage will be 100:1 (100,000/1,000). For a margin requirement of just 0.25 percent, the margin based leverage will be 400:1, using the same formula.
However, margin-based leverage does not necessarily affect one’s risks. Whether a trader is required to put up 1 or 2 percent of the transaction value as margin may not influence his or her profit or losses, as he can always attribute more than the required margin for any position.
Risk is an important factor when it comes to leverage. It is the investor’s responsibility to use the leverage in a smart way and control risks. If you have proper risk control and don’t overuse the buying/selling power given by this forex tool, you can take the highest leverage and never be worried that your account balance goes to the negative side.
Altogether, A trader that wants to succeed in forex online trading should always be aware of the amount of leverage he is trading and what it exactly means.