Forex leverage allows private investors to move large capital using small amounts of money. The broker can be compared to a bank which lends you 100,000 dollars to buy a currency pair and all it asks is that you give it 1,000 dollars as fiduciary deposit. It seems too good to be true? Well, leverage in Forex works so. The leverage amount which you can use depends on the broker and your risk tolerance.
Generally, the broker requires as initial deposit or initial margin, a minimum amount in the account. After depositing this amount in your account, the broker enables you to operate. He also specifies the required margin for each lot traded.
For example, for every 1,000 dollars you have in your account, you can negotiate 1 lot of 100,000 dollars. if you have 5,000 dollars, you can buy/sell 500,000 dollars.
The minimum guarantee (margin) for each lot is different from broker to broker. In the above example the broker requires one percent(1%) of margin. This means that for every 100,000 dollars, the broker wants 1,000 dollars as a deposit for the open position.
If the money in your account decreases below the required margin (usable margin), your broker will close some or all of your open positions. This prevents that your account goes in red, even in a volatile and fast market. For example, suppose you open a standard Forex account, with 2,000 dollars. In this way you can buy or sell 1 lot of the currency pair EUR/USD with 1,000 dollars. The usable margin is the money available to open another position or to support a possible loss. Since the initial deposit is 2,000 dollars, your usable margin is 2,000 dollars, but when you buy/sell a lot that requires the margin of 1,000 dollars, your usable margin becomes 1,000 dollars. If your loss exceeds your usable margin, you will receive a margin call.
Let's take another example. Suppose you open a standard Forex account with 10,000 dollars and that the margin requirement for 1 lot of the currency pair EUR/USD is 1,000 dollars. Usable margin is the money available to open another position or to support a possible loss. In this case, before to open a position, you have a usable margin of 10,000 dollars. Once opened your trade, you have a usable margin of 9,000 dollars. If your loss exceeds the usable margin of 9,000 dollars, you will receive a margin call.
It's important to understand the difference between usable margin and used margin. If the equity (balance) of your account falls below the value of the usable margin due to a loss, you will have to deposit additional money or your broker will close open positions to limit the risk. The consequence of this is that you can never lose more than your deposit. If it's your intention to work with margin, it's vital to know the policy of your broker about it.
Margin is a controversial topic, and someone says that too much margin is dangerous. Everything depends on the trader. The most important thing is to understand the policy of your broker regarding the margin.
Some brokers describe the leverage in forex in terms of ratio, others in terms of margin percentage. Relationship between the two terms is as follows: leverage = 100 / margin percentage.
Leverage is conventionally indicated as a ratio. For example 1:1, 10:1, 50:1, 100:1 or 200:1.
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