What is Leverage?
Learning about leverage in the forex market can be intimidating. All forex trades utilise leverage, and it’s one of the primary reasons for the high risk factor associated with currency trading. As such, it’s absolutely crucial that you fully understand how leverage works before you get started as a forex trader.
In this guide, I draw on my 20 years of experience as a forex trader to explain the use of leverage and margin accounts in clear, easy-to-understand language for beginners. Let’s dive in!
What is leverage in forex?
The term “leverage” is used to describe when traders borrow funds in order to open trading positions.
Funds deposited into what’s known as a margin account become a form of collateral against what is essentially a loan from a forex broker. That “loan” allows forex traders to leverage their funds and open forex trades that are far larger than their account balance.
Each margin account has its own individual margin requirements that must be met before you can use leverage.
For example, if your forex trading account has a 10% margin requirement and you want to open a position worth $100,000, you’d need to deposit at least $10,000 as collateral. If you used the full $10,000 to open a $100,000 position, you would be using a leverage ratio of 10:1.
Forex trading is already risky, and leverage introduces significant additional risk; gains and losses are both amplified when trading with leverage.
What is margin?
All retail spot forex trading is conducted within a margin account provided by a forex broker. Technically speaking, margin simply refers to the amount of capital a trader has within their trading account. In practice, margin accounts allow forex traders to borrow funds from their broker to buy assets and control investment positions.
The account balance (the margin) deposited by the trader becomes a form of collateral for the borrowed funds. Depositing funds into a margin account unlocks the ability to use leverage when buying or selling derivatives such as stocks, commodity futures, forex, CFDs, and other derivatives from a brokerage account.
When a leveraged trade is closed, the margin funds are freed up to be used again (except in the rare cases where margin funds have been lost entirely or are at risk – more on that later).
Margin is just a word for the amount of capital in your trading account. If you’re trying to wrap your head around the relationship between leverage and margin, remember that zero leverage = 100% margin. If you aren’t using any leverage to open a forex position, it means you are using 100% of your margin.
How is leverage used in forex?
Generally speaking, forex traders use leverage in order to open proportionally larger trading positions than would have been possible using just their own account balance. Some traders might use leverage in order to minimize the amount of their margin balance used for a given trade. Other forex traders might use their entire margin balance to maximize the size of their trade and, hopefully, greatly increase their profit potential.
Leverage ratios and what they mean
A good rule of thumb for reading leverage ratios is to think of the number on the left side of the ratio as the multiplier. The “multiplier” number represents the number of times you can leverage each unit of currency. With a leverage ratio of 10:1, for example, you can control ten units of currency for each unit in your account balance.
To expand a bit further, let’s imagine that your account balance is $10,000. Using a leverage ratio of 20:1, you could potentially open a position worth $200,000 (20 X 10,000 = 200,000).
Here are some examples of leverage ratios and their respective margin requirements:
|Leverage Ratio||Margin Requirement||Notes|
|1:1||100% margin||No leverage, fully collateralized|
|2:1||50% margin||This is the maximum leverage in the EU for crypto CFDs.|
|5:1||20% margin||This is the maximum leverage in the U.S. for stocks, and for stock CFDs in the EU|
|30:1||3.33% margin||This is the maximum allowed leverage in the EU for major forex pairs.|
|50:1||2% margin||This is the maximum allowed leverage in the U.S. for forex.|
|1000:1||0.10% margin||These extreme levels of leverage are usually offered by scam brokers and are not recommended for any trading strategy.|
How much leverage should you use when forex trading?
There is no single, correct answer as to the appropriate amount of leverage to use when trading forex. There are a number of factors that can vary depending on each trader’s individual trading goals and financial situation.
As a general rule, using less leverage can give you greater control over managing your risk and reward potential (though you can still lose money when using less leverage). Greater leverage can lead to faster gains and losses. Factors that can affect a trader’s choice on leverage include the following:
- Financial suitability
- Investment objectives
- Time horizon
- Risk tolerance
- Trading budget
- Trading style
Why is leverage risky?
Unless you are an experienced forex trader, excess leverage is unsustainable and will likely lead to losses. Leverage, when used appropriately, can be a powerful tool. But it must be stressed that leverage can amplify your potential profits and your potential losses. Unforeseeable events in the market can sometimes cause large, rapid movements in exchange rates. Even small swings in an exchange rate can swiftly turn into significant losses.
You can lose 100% of your account balance when using leverage.
Typically, a liquidation call would be able to close you out of your position in time to limit your losses in the event that the market quickly moves against you. That said, some events – such as market gaps – can put your entire balance at risk.
What is a market gap?
In forex jargon, the market “gaps” when the price of a given currency pair abruptly moves up or down with little trading occurring in between. When this happens, the pair’s chart will show a gap in its pricing pattern.
If there is an unforeseen flash crash or extremely volatile event, and the market gaps dozens of pips at once, overleveraged forex traders can sustain heavy losses.
Remember: Forex brokers can only exit trades at the next available price.
What is the best forex leverage calculator?
Though beginners can benefit from the use of a standalone online leverage calculator, most forex traders use the tools that are available directly within their broker’s trading platform.
For example, IG’s industry-leading web platform will display margin requirements directly within the ticket window:
To learn more about why I consistently rank IG at or near the top of every important category for forex brokers, check out my IG review.
What forex brokers have the highest leverage?
The brokers that offer the highest leverage are typically unregulated and/or based in high-risk jurisdictions that offer little to no oversight or consumer protections.
Trustworthy forex brokers typically only offer the maximum leverage permitted by applicable local regulations. These limits can vary from country to country; in some reputable jurisdictions, the maximum leverage ratio can range from 100:1 up to 400:1.
Switzerland, for example, allows up to 400:1 leverage. Despite being part of the European Economic Area (EEA), Switzerland is not a member of the EU and thus is not restricted to the margin requirement imposed by the European Securities Markets Authority (ESMA).
Here is a list of highly rated forex brokers that are regulated in Switzerland (check out my guide to forex trading in Switzerland):
Important reminder: Using extreme levels of leverage introduces significant risk and can lead to substantial losses.
What is 10 to 1 leverage?
Ten-to-one leverage, written as 10:1, is a leverage ratio that denotes a 10% margin requirement. With a leverage ratio of 10:1, you have the ability to control ten dollars for every dollar in your margin account.
Let’s say you want to open a position on a forex trade worth $10,000. If you decide to use leverage at a ratio of 10:1, you could open that $10,000 position with just $1,000 in your account. You would put the $1,000 down as a form of collateral with your broker, and the broker would lend you $9,000 to open the trade. The $1,000 in your account would be the margin requirement for the $10,000 trade.
What does a margin call mean in forex?
A margin call in forex trading occurs when an open position is automatically closed due to a lack of available margin, usually because the position has fallen at or below the account’s margin requirement. This is also known as a liquidation call, a “close out,” or a “stop out.”
Trades or open positions are closed (or liquidated) in order to prevent your account balance from going into the negative. In most cases, once a margin call closes your open trading position, the margin left in your account is freed up and becomes available to open new positions.
The potential for incurring a negative balance in your margin account due to the use of leverage is one of the main reasons why trading derivatives like futures, forex, or CFDs from a margin account can be extremely risky. Extremely volatile market events can cause gaps in market prices. If the value of that gap is greater than the value of your used margin, your losses can exceed your account balance.
How does margin in forex compare to margin in stock trading?
Any similarities or differences between the use of margin in forex trading and stock trading will depend on your home country, the exchange on which you are trading, and the broker you are using, among other variables. That said, there are a few important differences between the two that can be helpful to point out:
Going long or short. When trading forex, your ability to use a margin account is the same whether you go long or short to open a trade. When trading stocks, there are different rules that govern the use of margin accounts when opening short positions.
Margin calls. When trading forex, trades are typically liquidated and closed in real-time during a margin call. When trading stocks on the stock market, you may have more time to send in additional funds.
As I mentioned above, the rules surrounding the use of leverage can vary from country to country. In the EU, for example, leverage is restricted to 30:1 for major currency pairs and 5:1 for stock CFDs. In the U.S., on the other hand, leverage is restricted to 50:1 (and margin requirements were recently increased for currency pairs involving certain currencies.).
For stock traders in the U.S., Regulation T sets a limit at 50% of your balance, or 2:1 leverage, (see FINRA’s rule 4210 definition). That said, many U.S. brokers can offer up to 4:1 for stock traders who can be categorized as pattern day traders.
More educational resources for new forex traders
Now that your foundation of forex knowledge includes the ins and outs of currency trading, the ability to read pips and currency pairs, and the intricacies of using leverage from within a forex margin account, you can start to prepare yourself to start trading forex. Head on over to the final chapter in this educational series to see my tips for getting started as a forex trader.