Investing > Forex Leverage Explained

Forex Leverage Explained

Leveraging your forex trades can lead to big wins. This guide covers how to balance risk and be smart about your trades.

By
Reviewed by
Updated June 11, 2021

All reviews, research, news and assessments of any kind on The Tokenist are compiled using a strict editorial review process by our editorial team. Neither our writers nor our editors receive direct compensation of any kind to publish information on tokenist.com. Our company, Tokenist Media LLC, is community supported and may receive a small commission when you purchase products or services through links on our website. Click here for a full list of our partners and an in-depth explanation on how we get paid.

Entering the world of forex?

Everyone is crazy about forex nowadays—but many are losing a ton of money because of high leverage. Using leverage to maximize gains seems attractive at first—but there’s a lot more to it.

Before you dive in feet first, it’s important to understand the pros and cons of trading forex to avoid its pitfalls. While using borrowed capital for your investments can lead to big returns, it can lead to equally big losses. 📉

Don’t worry – forex leverage can be confusing for all beginners, and we’re here to make the path more clear! As forex trading has increased 300% since the COVID pandemic, you’re certainly not alone in your new studies. This article will help you understand the meanings of leverage and margins, how this affects your trading, and how you can get started trading forex today.

What you’ll learn
  • What Exactly is 'Leverage'?
  • What's Trading on 'Margin'?
  • How Much Can You Leverage?
  • Margin Requirements
  • How Leverage Affects Your Trading
  • Learning Check: Quiz
  • How Much Leverage Should I Use?
  • Negative Balance Protection
  • How Forex Brokers Generate Revenue
  • Terms You Need to Know

What Does Leverage Mean in Forex? 💡

If you’re just starting out with forex trading, make sure you understand the essentials of forex trading. Only once you pass the basics will you be able to use leverage to amplify your gains in forex and bring home more of that cheddar. 

“Leverage” means using a small amount of your own money in order to control a much larger amount of money. Typically, you borrow the remaining amount through your broker. 

For example, say you want to control a $50,000 position. Your broker might put aside $500 of your own money and borrow the remainder. You now have control over the $50,000 with just $500 from your own account, so your leverage ratio is 100:1. 

Now, let’s say the $50,000 investment rises by $500, so the full position is now worth $50,500. If you were liable for the full $50,000 (representing a 1:1 ratio), this is only a 1% return on your investment. However, since you only put in $500 of your own capital, the $500 increase represents a 100% return on your investment – that’s way more exciting! 

This image shows how a forex trader can make a $50,000 trade by depositing only $500 and using leverage with a ratio of 100:1.
Forex trade with a 100:1 leverage ratio

Now, it’s important to understand that this cuts both ways. If you lost $500 instead of gaining $500, you would see a -100% return on your investment. Yikes! If you had a 1:1 ratio and put in the full $50,000 you would only see a -1% return. 🤷‍♂️

People like Jason Maynard have made their careers on leverage trading – but it takes some work and some luck to win big, and there’s always the risk of failure. That’s why understanding the ins and outs of leverage trading is so important! 

What is Margin Trading? 🔎

Margin trading in the stock market is similar to forex leverage trading, but there are important differences. A margin account is money that you borrow in order to invest in a certain security or currency. 

Margin trading uses the practice of leverage in the stock market, while forex trading applies the principle to the forex market. Forex trading does not charge interest on the margin use, and it does not rely on your credit as margin trading does. Both types of trading have the same high risks and high rewards.

How Much Can You Leverage in Forex? 💱

Before you open an account with a broker, you’ll want to check the maximum leverage ratio that you’ll be able to use. The higher the ratio, the bigger your potential gains or losses. Brokers will usually offer 50:1, 100:1, 200:1, or 400:1 ratios. EFT Markets just announced that they will use leverage up to 400:1.

Leverage ratios are often regulated by governments, and there are two agencies responsible in the United States. The main regulator in the EU, The European Securities and Markets Authority passed regulations in 2019 requiring initial margins to be no lower than 20:1, which was likely disappointing news for forex traders in the Old Continent.

A typical ratio on a standard lot account is 100:1, and a mini lot account will often offer a 200:1 ratio. If you start trading at 400:1, be wary of using small deposits to control large capital, as these can disappear quickly with the volatility of large sums. Lower leverage keeps you safer from mistakes, while higher leverage could bring in higher rewards. 

Margin Requirements 📄

A “margin” refers to the amount of money that you put in to control a given position. In the above example, the margin refers to the $500 of your own money that secures your control over the $50,000 of capital. 

A margin will be expressed as a percentage of the full amount you control, and different brokers will require different margins. The above example represents a 1% margin. A broker will pool your margin with margins from other customers in order to create a deposit to place trades. 

You can use the margin requirement from a broker to calculate how much leverage you can control. For example, if your broker requires a 5% margin, your maximum leverage will be 20:1. If your broker requires a 0.5% margin, your maximum leverage will be 200:1.

The following table breaks down some common margin requirements and how they correspond to your maximum leverage. 

Margin RequirementMaximum Leverage Ratio
2%50:1
1%100:1
0.5%200:1
0.25%400:1

How Leverage Affects Your Trading ✅

As we’ve seen, leverage is a powerful tool that can help you win big in the forex market. You can use less capital to control greater positions, giving you flexibility and amplifying your profits. However, it can just as easily amplify your losses. 

At very high levels, leverage starts to damage your odds of success. Transaction costs represent a higher percentage of your margin the greater your position is. This means that transaction costs already put you at a disadvantage with excessively high leverage.

Pros

  • Magnify your gains by controlling significant positions
  • Flexibility to control positions without tying up large amounts of capital 
  • Speculate on the market and benefit from falling markets
  • No interest charged on your margins 
  • Trading 24 hours in the forex market 

Cons

  • Magnify your losses by controlling significant positions 
  • Margin calls may force you to increase your capital or close a position 
  • At extremely high leverage positions, transaction costs can eat up most or all of your margin 

Pop Quiz! 🎓

Let’s check to make sure you’re following! Don’t stress, we won’t be grading you. 

After reading this article, you’ve decided to get started in forex leverage trading. You find a broker that has a $2,000 minimum deposit, which you can make. The broker offers 100:1 leverage.

👨‍🏫 Question: How much capital will you be able to control with your $2,000 deposit?

Answer: You’ll be able to control $200,000 of capital with your minimum deposit. Did you get a different answer? Don’t worry – you can review the leverage ratios above, or find a reliable forex trading app that will help you with these calculations. These apps can help users create a plan and have discipline in their trades.

How Much Leverage Should I Use? ⚖️

Professional traders often use low leverage in order to protect their capital and ensure consistent returns. These amounts might even be as low as 10:1 or 20:1. This will mean depositing more money and making fewer trades than your broker might allow. Just because your broker allows higher leverage doesn’t mean you can’t trade at these levels. 

Especially as you are starting out, or if you are risk-averse, lower leverage ratios will work well for you. As you get a feel for the market, you may decide to use higher leverage in order to take bigger risks. You’ll need to balance your experience and risk tolerance to decide the leverage that is right for you. 

As you’re making your picks, stay on top of market trends and predictions for 2021 as the COVID-19 vaccine changes the forex market through 2021. we see a rollout of the COVID-19 vaccine and a potential return to normalcy. 

In order to understand how different leverage ratios might affect your losses, let’s imagine two Traders: Trader 1, and Trader 2. Both invest $1,000 of their own capital, but Trader 1 uses a high leverage ratio of 100:1, while Trader 2 uses a lower leverage ratio of 5:1. The following table breaks down what would happen to each trader in the case of a 100-point loss.

Potential Risks of High LeverageTrader 1Trader 2
Capital Invested$1,000$1,000
Leverage Ratio100:15:1
Value of Position Controlled$100,000$5,000
Result of a 5% Loss-$5,000-$250
Value of Capital Remaining-$4,000$750

As you can see, the lower leverage safeguarded Trader 2 with this relatively low amount of capital invested from a fluctuation in the market. 

Negative Balance Protection ⚠️

Negative balance protection will keep your accounts from being negative even if the market moves quickly against your trade. This is a great feature for beginners who are not used to volatile swings in the market. All of the top forex brokers for beginners provide negative balance protection, as they should since newbies are the most susceptible to making brash, overly leveraged trades. 

Negative balance protection will create a margin call if you are quickly losing money on a trade. This is vital as it will keep you from going into debt on your trades. The market volatility is part of what makes forex trading exciting and lucrative – just don’t let it wipe out your funds! 

How Forex Brokers Generate Revenue 💸

There are several types of brokerages, and there are a few ways forex brokers make money. The traditional way brokers make money is by profiting from fluctuations between the bid/ask price of a currency pair, attaching a commission or fee to your trade, or charging for services. 

Though less frequent, your broker may also make money from affiliate marketing, partner programs, loan financing, or charging interest or a fee on margin loans. All in all, even though the top forex brokerages of the world have great prices, you should check their fee structure carefully before proceeding. 

Leverage-Related Terms You Should Know 📚

We’ve gone over a lot of terms in this article already, and it’s important to keep them all straight. The following are key terminology you need to understand in order to be a successful forex trader. 

  • Leverage Ratio: This expresses the relationship between the capital you put up versus the position you control. 
  • Margin: This refers to the capital you put in.
  • Margin Requirement: Expressed as a percentage, this is a number from your broker that will tell you how much capital you can control based on what you put in. 
  • Used Margin: The amount of your capital that your broker has used to control your positions.
  • Usable Margin: The amount of capital in your account that can still be used for new positions. 
  • Margin Call: This is triggered when the money in your account is less than your potential loss. A broker may close some of your positions to cover this discrepancy. 
  • Negative Balance Protection: Particularly important for beginners, this will trigger a margin call if you are losing money rapidly to keep you from going into debt.

How to Trade Forex with $100 💹

You’re almost ready to start trading forex! Let’s say you have just $100 to get started. We’ve seen that different leverage ratios will allow you to control different amounts of capital. If you invest with 10:1 leverage, you’ll be able to control a $1,000 position. If you invest with an extremely high ratio like 400:1, you’ll be able to control a $40,000 position. 

Now, with smaller amounts of capital and especially as a beginner, it’s smart to keep your leverage ratio low. This will keep your $100 from being eaten up by transaction fees of a $40,000 position, which could immediately trigger a margin call and give you zero chance of increasing your investment.

If you want to start forex trading and see consistent returns while you get a feel for a market, opt for a low leverage ratio with the capital you have. Some of the best forex brokers in the world, including TD Ameritrade’s forex platform, don’t require a minimum deposit. 

Forex Leverage FAQs

  • How Much Money Do You Need to Trade Forex?

    Technically, you can begin using leverage to trade forex with any amount of money! Many brokers can get you started with as little as $100. However, we recommend using very low leverage ratios with small amounts of capital to avoid your entire margin getting eaten up by large transaction fees. 

  • How Much Can You Make Trading Forex?

    Dedicated forex day traders usually aim to increase their portfolios by 5% to 15% per month. However, when using leverage, profits can also be much greater—and lower. An overly-leveraged leveraged forex trade has the potential to wipe out your balance, so the key to making steady growth is by increasing your portfolio by 0.5% to 1% every day through safe trades.

  • How is Forex Trading Taxed?

    Forex futures and options are 1256 contracts. This means they are taxed using the 60/40 rule: 60% of gains or losses are regarded as long-term capital gains, while 40% are treated as short-term capital gains. This often benefits those in higher tax brackets, as short-term capital gains are taxed as ordinary income (up to 37%), and long-term capital gains will be taxed closer to 20%. It’s always a good idea to consider tax implications and consult a professional before you embark on a new financial endeavor. 

  • Do You Have to Pay Back Forex Leverage?

    No, you do not have to pay back the debt that is leveraged along with your margin. However, it is still possible to owe more than you initially put in. This is why we recommend negative balance protection to trigger a margin call if one of your trades is losing money rapidly. 

All reviews, research, news and assessments of any kind on The Tokenist are compiled using a strict editorial review process by our editorial team. Neither our writers nor our editors receive direct compensation of any kind to publish information on tokenist.com. Our company, Tokenist Media LLC, is community supported and may receive a small commission when you purchase products or services through links on our website. Click here for a full list of our partners and an in-depth explanation on how we get paid.

Cookies & Privacy

The Tokenist uses cookies to provide you with a great experience and enables you to enjoy all the functionality of the site.