Investors use leverage to significantly increase the returns they can get on any given investment. In forex, investors use leverage to profit from the fluctuation in exchange rates between two countries. Forex also boasts some of the highest leverages available to investors in the market.
Leverage can best explained as a “loan” that is provided to the investor by the broker where the account is housed. When an investor decides to invest in the market, he or she must first set up a margin account with a broker. Usually, the mount of leverage provided is about 50:1, and can vary depending on your broker. Trading is done in lots of 100,000 units of a particular currency.
To trade $100,000 units of USD with a $1,000 deposit, you would need to have leverage set to 100:1. Leverage of this size is significantly larger than the 2:1 leverage commonly provided on equities or the 15:1 leverage provided in futures. Although 100:1 may seem exceedingly risky, the risk is less when you consider that prices in currencies usually change by less than 1% during daily trading.
Leverage can also hurt a trader, however, if the currency underlying one of the investor’s trades moves in an unpredicted direction, the leverage will greatly amplify the potential losses as well as the potential gains.