If you are a trader — or an aspiring one, you might have come across this term a countless times already. However, do you truly understand what leverage is?
Leverage is used to amplify a trader’s market capital so that they will be able to control bigger market positions that exceeds their initial investment.
Does it still sound so confusing?
Okay, so let’s put it this way.
For example, a trader invested an amount of $500 in his trading account. Such an amount would not be sufficient to buy 1 lot of EUR/USD pair, which costs around $100,000. Logically speaking, looking how small your initial investment is, it might seem impossible for you to buy a “lot” of EUR/USD. But in the vast world of forex trading, that’s a different story.
Most forex brokers nowadays allow you to benefit from a high leverage ratio. Commonly, most forex companies provide their clients with a leverage ratio of up to 1:400. A leverage of that amount would be equivalent to a value 400 times your initial capital. It looks like basic mathematics, right? Yes, it is. Say for example, you have $1 of initial capital in your account, and with a 1:400 leverage, that would be $100 x 400 = $400 worth of capital.
With such a high leverage ratio, having a $500 initial investment would be sufficient to buy not just one, but two lots of EUR/USD! That’s like putting your capital on steroids. It sounds so amazing, right? Of course, because it is!
However, despite all the advantages leverage has to offer, it also carries a substantial amount of risk. Leveraging your capital will magnify not just your profits, but also your losses. Trading in forex involves a high level of risk, but with proper knowledge and understanding of the market, these risks can be reduced considerably.