What is leverage in the financial markets

Raycho Angelov | 17.06.23 | 4 минути за прочитане

In this article, you'll discover how to effectively utilize leverage, calculate it accurately, and avoid common beginner errors.

Additionally, you'll gain insight into how leverage is connected to margin and learn which leverage levels are appropriate for your trading activities.

Let's get started!

What is leverage

How much leverage should you use

The relationship between leverage and margin

What is leverage

Leverage allows you to trade with more money than you have.

It enables traders to amplify the impact of a trade by multiplying the invested funds.

In other words, the broker provides loan capital so that you can trade, but requires you to deposit a certain amount as a guarantee to cover potential losses.

For example, to manage a position of $10 000, the broker will allocate $100 of your capital. In this case, the leverage used is 1:100.

Alternatively, it can be stated that each dollar deposited provides 100 times more purchasing power with 1:100 leverage, 200 times more purchasing power with 1:200 leverage, and so on.

The amount the broker requires varies with the level of leverage and is referred to as the margin.

An example further down in the article illustrates the relationship between leverage and margin.

You can learn more about margin in the following article:

>> What is margin in the financial world

Formula for calculating leverage:

Leverage = Trade size / Required margin

For instance, if a margin of 1% is needed for a 1 lot trade on EURUSD, which amounts to EUR 100 000, the required margin would be EUR 1 000.

Here's what that looks like:

Leverage = 100 000 (lot size) / 1 000 (margin required)

Leverage = 1:100

One of the most common questions is what leverage should I trade with?!

Keep reading!

How much leverage should you use

In the Forex market, brokers offer 1:100, 1:200, 1:400, and even 1:1000, which sounds great.

Find out how to begin your trading career

>> Forex Trading: A Complete Guide for Beginners

High leverage can be risky if not used correctly by the trader. The table below shows how varying levels of leverage impact the required margin for an account with EUR 10 000 equity.

Leverage

Possibility to buy/sell 10,000 EUR

Margin in % (Margin requirement)

Margin in EUR for each standard lot

1:20

200,000 EUR (2 standard lots; 20 mini lots)

5%

5000

1:50

500,000 EUR (5 standard lots; 50 mini lots)

2%

2000

1:100

1,000,000 EUR (10 standard lots; 100 mini lots)

1%

1000

1:200

2,000,000 EUR (20 standard lots; 200 mini lots)

0.5%

500

1:500

5,000,000 EUR (40 standard lots; 500 mini lots)

0.2%

200

Let's look at the following examples:

Example #1

  • Deposit - EUR 1 000;
  • Leverage - 1:20;
  • Margin requirement - 5%;
  • EUR/USD trade with a volume of 0.1 lots (10,000 currency units);
  • Required margin - EUR 500;
  • Take Profit 100 pips - profit $100.

Example #2

  • Deposit - EUR 1 000;
  • Leverage - 1:500;
  • Margin requirement - 0.2%;
  • EUR/USD trade with a volume of 0.1 lots (10,000 currency units);
  • Required margin - EUR 20;
  • Take Profit 100 pips - profit $100.

As leverage increases, the required margin decreases, making it possible to trade larger volumes without putting excessive strain on the account.

Realistically, it doesn't matter what leverage you use if you have a good money management strategy.

It's more important to know how much you can afford to lose on a trade than to worry about whether your leverage is high.

If you have a small account and use low leverage, you may not have sufficient free margin to execute all the trades you identify. In such cases, opting for a higher leverage might be more effective.

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The relationship between leverage and margin

The higher the leverage, the lower the required margin. However, high leverage doesn't change the pip value.

If you have an account of $10 000 with a leverage of 1:100 and place a full lot trade on EUR/USD, the pip value would be $10 and the required margin would be $1173.8 (at a rate of 1.1738 on EUR/USD).

Having the same $10 000 account and trading a full lot but with a leverage of 1:500 means that the pip value remains $10 but this time the required margin will be five times smaller - $234.7.

Therefore, if your Stop Loss is hit, the loss in both cases would be $1 000.

Download a trading platform and open your demo or real account to test what you've learned.

Trade with a secure broker

Founded in 2010, ThinkMarkets is a premium online multi-asset trading broker with offices across the globe including Australia, Asia, Japan, Europe, UK, UAE, and clients in more than 165 countries.

Many people believe that high leverage in itself increases the risk of loss, but the example above shows that this is not exactly the case.

It simply provides the opportunity to trade with larger volumes but does not require you to do so.

It became evident that the leverage you use is less important than the loss you set for each trade.

High leverage allows you to fully utilize your account by trading the maximum volume relative to your capital to potentially achieve greater profits. However, this also carries a significant risk of losing your entire account.

This should only be done with small accounts designated for high-risk trading.

The capital for such an account shouldn't affect your living standard or monthly budget if lost.

In conclusion, I will add that everyone should determine the degree of risk on their account.

You can use high leverage wisely and take advantage of it, so don't stress about high leverage. It won't change anything unless you do!

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