The definition of leverage could be easily summed up in four words: “Doing more with less”.
Leverage is essential for retail traders to make money from Forex trading. The reason is that the average volatility (percentage-wise) of a major currency is less than 1%, whereas a stock can easily have a 10% price move on any given day.
This means you need more capital to benefit from fluctuations in the currencies. Because not many retail traders are able to provide $100.000 to trade one standard lot, Forex brokers provide retail traders with leverage so that they do not need to lay out the entire sum.
As such, if the broker provides you with leverage of 100:1, all you need to do is pay $1000 to trade one standard lot. This sum is referred to as margin, and below you will see a more detailed description of it.
What is Margin ?
Margin could be described as the amount of money or collateral deposited by a customer with a broker. In other words, it is a “good faith deposit” required by the Forex broker to cover the position you have entered into the market.
The margin will be used with in combination with leverage to open and maintain your positions, and to cover any potential losses.
Margin requirements will differ from one broker to the other, as well as from one currency to the other. More volatile pairs will typically require more margin for trading.
Keep in mind:
- margin trading is trading with borrowed funds, and is closely related to leveraging.
- leverage is provided by brokers, and it allows you to control a larger amount of funds;
- leverage does not affect the value of a lot, but it does allow you to trade more;
- the higher the leverage employed, the less margin you need to control one standard lot.
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