Leverage
Almost all traders are familiar with leverage, which can be used to potentially earn a significant profit, even if the trader’s own deposit is relatively small. In this regard, traders are divided into two camps: some argue that leverage should not be used, while others support the opposite view. To understand the situation clearly, it’s important to take a closer look at how leverage works.What Is Leverage
Leverage is a tool that allows a trader to buy a tradable asset (such as a currency pair, stocks, etc.) for an amount larger than the funds available in their account. For example, a leverage ratio of 1:10 enables a trader to open a position ten times greater than their actual deposit. Typically, leverage ratios include 1:10, 1:50, 1:100, 1:200, 1:500, and 1:1000. In some cases, leverage may be either lower or higher.It’s important to note that a Forex broker sets the available leverage based on the account type and the trader’s deposit. In other words, the simpler the account type (such as Mini, Cent, etc.) and the smaller the balance, the higher the leverage offered. Conversely, the more advanced the account type (for example, ECN, STP, NDD, and so on) and the larger the deposit, the lower the leverage available to the trader.
Unlimited Leverage
Unlimited leverage (1:∞) is an innovation offered by some brokers, allowing traders to open positions with a very small margin. In other words, a trader’s own funds are almost not required to enter a trade. With unlimited leverage, even a slight price movement against the trader’s position can wipe out their deposit, while conversely, if the price immediately moves in their favor, the trader can earn a significant profit. It is very similar to roulette, where the outcome is largely out of the player’s control. Nevertheless, unlimited leverage remains in demand among traders.How Leverage Works
To understand how leverage works, it’s best to look at some examples.For instance, a trader has $10,000 in their account and a maximum leverage of 1:100. Let’s consider two scenarios: the first is a EUR/USD buy trade without leverage (1:1), and the second is the same buy trade (for the same asset) with 1:100 leverage. We will look at the outcomes for both a 10-pip profit and a 10-pip loss.
First Scenario – Trade Without Leverage
If leverage is not used, the trader can buy 0.1 lot (10,000 units of currency) with their entire deposit. The value of one pip will be $1. Both the profit and the loss in such a trade without leverage will be: $10 (10 pips × $1 = $10).After a trade without leverage, the deposit will change by 0.1%, becoming $10,010 or $9,990.
Second Scenario – Trade With Leverage
If a trade uses 1:100 leverage (for every 100 units of money provided by the broker, we only need to put in 1 unit of our own money), the trader can buy 10,000 × 100 = 1,000,000 units of currency, which equals 10 lots. The value of one pip will be $100. Both the profit and the loss in this trade will be $1,000 (10 pips × $100 = $1,000).After a trade with leverage, the deposit will change by 10%, becoming $11,000 or $9,000.
From these examples, we can see how the trade size—and consequently, the profit and loss—changes with and without leverage. However, it’s important to keep in mind that free funds will also be required in the trading account to maintain the margin.
Conclusion
From the examples, it is clear that increasing a deposit using leverage is entirely possible, but the risks of wiping out the account are very high. Therefore, to avoid losing all your funds, it’s important to carefully consider the choice of leverage.
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