Forex trading has become more and more popular in recent years. With a very active and liquid market that is open 5 days a week, 24 hours a day, there is no doubt there is a variety of possibilities to make a healthy profit in the currency exchange world.
For those that are not familiar with what forex is, it basically refers to the exchange of one currency for another to make a profit.
Currencies are presented in pairs with a bid price and an asking price that always leaves a difference, known as a spread.
There are many forex brokers out there, some offer very low spreads, others concentrate on an intuitive and easy-to-use online platform. But when it comes to forex, other aspects may determine what broker is the best for you. Concepts like margin and leverage play an important role in what broker to choose.
If you’re interested in high leverage forex brokers or prefer the lowest spreads, keep this in mind when browsing around for the perfect broker for you.
Definition of leverage in forex trading
Leverage is the money a trader can borrow, usually from the broker, to invest in a currency.
The whole concept of leverage plays a huge role in the currency exchange market because it allows traders to exponentially increase the returns of a good deal.
However, leverage should be used with care and based on experience and research. Using leverage on your currency exchange deals increases your chances of making a profit, but it equally increases the risk.
Leverage comes in ratios like this 100:1. This means that with 1 thousand dollars, traders can make a deal for 100 thousand dollar
There is a requirement from the broker called “margin” and they determine the leverage ratio. Basically, the lowest the margin requested by the broker, the highest the leverage ratio.
Why is that?
Because the margin is the deposit that traders have to give the broker in order to borrow that money they want for a big exchange. The percentage of margin usually goes from 2%, 1%, .5%, or .25%.
The margin and the leverage ratio may change depending on the currency pair, but also considering the type of market and the current financial situation.
What are the risks of leverage?
Well, it’s rather simple, leverage can magnify the potential profit the same way it can do it for the losses.
To avoid immense losses, brokers have stop-loss orders in place, allowing the traders to get out of a deal going south, making it more manageable to deal with the losses.
Leverage requires practice and experience and a very hands-on approach. It’s a flexible tool that every trader can use and adapt to their needs and trading style, as long as the risk enters the equation and is kept in mind.
Different kinds of margin in forex trading
There is a bit of confusion when it comes to the term “margin” since it’s used for different things and these are some of the terms traders will find referring to margin.
Trades will find the term “used margin”. This refers to the money the broker is using to lock your position. While this money still belongs to the trader, it’s not possible to touch it.
Margin requirement refers to the money that the broker needs in order to apply the leverage ratio.
Another common term is “margin call”. This happens when the amount of money you have cannot cover your losses. It’s a decision made by the broker.