Leverage in forex trading explained

Leverage in forex trading explained

As soon as you begin trading you will encounter the term leverage. The ability to trade with leverage provides the possibility for traders to make large profits with a small capital on tiny price fluctuations. However, trading with leverage does carry some risks.

This article is part of the interesting CFD trading course.

Leverage and the multiplier effect

As said before, CFD trading allows users to trade with leverage. The height of this leverage is always displayed as a ratio, e.g. 1:50. If the leverage is 1:50 and you have a balance of € 1,000, you can trade with as many as € 50,000. This way a greater amount of shares can be added to your portfolio.

How does leverage work?Leverage in forex trading explained

A leverage can be compared best with a kind of loan. The broker finances a large part of the position and the difference between the opening and closing price will eventually be the amount you have won or lost on your trade. You will never actually be the owner of the share, the broker will control both the purchase and sale. When trading CFDs you have no further responsibility since you are never were, are, or will be the physical owner of the share.

Advantages of high leverage

A major advantage of a high leverage is the fact that you can obtain high yields with a small capital. For example: If the share price increases with one euro and you use a leverage of 1:50, your actual profit will be € 50.00. However, when the price decreases with one euro you will of course lose the same amount. The gains and losses on your positions are usually added to your balance immediately. The difference between the opening price and the closing price is what determines your actual return.

Be careful with leverage!

You will not be the first to directly open a position with a leverage of up to 1:400. With higher leverages come higher risks, as your losses will be magnified with a factor of four hundred. The leverage effect works in both directions and it is therefore important to deal with that responsibly. Either do not use to high leverages or trade with smaller amounts in the beginning. It is better to first try and experience trading with leverage and once you get the hang of it you can increase the leverage or the size of your position to make larger profits!