Everyone heard about The Leverage!
This is this scary Thing that all experts warn us about?
Double edged sword some said…
Is it really so scary and we should stay away from it? I do not think so…
So what this leverage really is? (Keep it simple Dorothy!)
Leverage is money that your broker lends you, so you could trade in decent size! Or money that you borrow from your broker to trade in decent size!
In 2 sentences we covered the whole concept of leverage in finance and used very confusing for non-English speakers – lend-borrow couple.
So how leverage 1:500 really works?
For every $1 of your good faith deposit (margin / money you post with your broker) , the broker will lend you $499 USD so you could trade( buy or sell) in bigger size and conquer the world so much quicker!
Forex Tip: Leverage= margin required! Both are one and the same thing expressed differently!
Margin required: amount of good faith deposit that your broker requires so you could open the trade of given size, usually expressed as percentage.
So your free margin deposit of 20 000 USD will allow you to buy or sell the underlying assets (USDJPY?) worth up to USD 20 000* 500= 10 000 000 Million USD!
So to calculate maximum position value with your initial deposit and leverage of 1 to X, one needs simply multiply the deposit (free margin) and X.
Deposit of 6000 EUR and leverage of 1:200 will allow the trader to buy or sell up to 1 200 000 EUR worth of EUR/JPY.
From the required margin perspective: the higher leverage, the lesser margin required to open the position.
The margin required is always calculated in base currency of the forex pair. To trade:
- 1 million EUR/USD with Leverage of 1:100 we need 1 000 000 EURO/ 100 = 10 000 Euro or
- 1 million EUR/USD with Margin required of 1% we need 1 000 000 EURO*1% = 10 000 Euro
If the currency you chose for your trading account is different than EURO, the margin will be converted to your account’s currency at the current rate.
Margin required is calculated in Base currency of the Forex pair
· Margin Required= Value of the trade in base currency/ Leverage or
· Margin Required= Value of the trade in base currency*Margin required as %
Please find the downloadable table below. Feel free to download it and play with numbers till you are fully comfortable with calculations!