The Concept of Leverage in Forex Business
Posted by TomShort on November 17, 2009 under Daily Forex review | 
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In terms of investment, when you leverage, you are basically borrowing on edge to increase the size of your Forex trade beyond what funds you have on hand. In stocks and other equities, you can create leverage trading on your Forex trade account, which may permit you to as much as double your purchase. However, in Forex platform, just doubling the purchase is usually not heard of in most cases. Depending on your broker’s terms, in Forex platform, you may be able to manage 50, 100 or even 200 times your account balance.
Therefore, leverage merely means using a small sum to control a much larger sum. This is achievable because it is unlikely that the value of a currency will alter by more than a certain percentage over a short time. So you can leave a few hundred dollars in your brokerage account to trade on the margin; and the amount that you think the price will fall. Your broker will in effect eventually lend you the balance. This can also lead to big profits if you are not successful, but it can also bring about big losses if not. In general, the more leverage you use, more risky your Forex trading will be.
Suppose, the current rate on the British pound to US dollar is shown as GBP/USD 1.7100, thus to buy one British pound you would need $1.71. If you expect the value of the dollar to rise against the pound you might decide to sell enough pounds to buy $100,000. If your broker uses lots of $10,000 each, these would be 10 lots. Then you would sit back and wait for the price to go up. A few days later you might find that the price had moved to GBP/USD 1.6600. Sure enough, the dollar has risen and the pound is now worth only $1.66. If you sell your dollars now and buy back into pounds, you will have made a profit of 2.9% less the spread. 2.9% of $100,000 is $2,900, so that would be an excellent trade.
When you are buying and selling different currencies at the same time, your own money only has to cover any loss that you might make if the dollar falls in its place of rising. And you would put a stop loss into place to limit that loss, so $1,000 might be all you needed to have in your account to make this $100,000 purchase. Your broker guarantees the other $99,000. Most of the Forex brokers now function limited risk amounts where the account will automatically close out the trade if whatever funds you have in your account are lost.
This process prevents margin calls, which can be catastrophic for a trader because they mean that you can lose more than you have. But with a Forex limited risk account that is not a possibility. The broker’s software that you utilize to manage your account will not let you lose more than your account balance. Using leverage is so common in currency trading that you will eventually do it without even thinking about it. Still it is important to remember the risks. Be careful to manage your leverage position when invyou are just an amateur.