Leverage is a measure of the force amplification achieved by using a tool, mechanical device or machine system in our daily life.
While in Forex, leverage results from the loan borrowed from the Forex broker to their traders. With brokers acting as a lever that turns minimum input (small capital) into greater output, leverage helps traders amplify their capital into more money. As such, traders get to obtain a higher profit from the fluctuations in exchange rates within a short period of time.
How does it work?
Let’s say trader A has deposited 1,000USD into his trading account and opted for a 1:100 leverage. The leverage increased his trading volume to 100,000USD, enabling him to open a lot with just 1,000USD.
With the help of leverage, trader A gets to gain 100% of his deposit (1,000USD) even if he only achieved a 10% profit from his trade (10% of 100,000USD).
Trading using leverage is what actually makes the market much more exciting and profitable. Without leverage, traders with small deposits might need longer time to gain profit due to the relatively small price changes in the Forex market.
Albeit leverage can be a substantial tool for traders to gain, it has the possibility to backfire as well. It is a multi-faceted, complex tool that can amplify traders’ trading volume yet downside risk concurrently. Same goes to gaining, a mere 10% loss can wipe out traders’ entire account.
Therefore, always think one step ahead and implement a strict trading style like the use of stop orders. In order to avoid a financial catastrophe, first time traders are less likely to be encouraged to use leverage until they acquire more experience under their belts.