Learn About Forex Leverage Trading

Price fluctuations when Forex trading are measured in pips, the smallest measurable price movement is a single pip with a value of £0.0001. Due to the tiny value of the price movements, it is necessary to trade in lots, a standard lot is 100,000 units, a mini lot is 10,000 and micro being 1,000 units. 

Obviously most traders will not have the capital available to purchase 100,000 units of currency, in fact most speculative traders begin with an account value of £10,000. This is where the brokers assist and offer their traders the opportunity to leverage their forex positions.

All online Forex brokers will offer leverage, levels will vary, but some will allow a position to be taken up to 100x the value of their account. If a trader initially deposits £1,000 to open an account, leverage of 100x would allow a position of 100,000 units.

The purpose of forex leverage trading is to create a trading position that is worth taking. Trading at higher levels increases pip value in accordance with the leveraged trade size i.e. 100,000 units x £0.0001 = £10.

The level of leverage that a trader should utilise depends entirely on trading experience and appetite to risk. If new to trading, it is strongly recommended to trade with low levels of leverage, perhaps 5x. Brokers may offer up to 100x leverage which is extremely tempting to new traders, but trading with leverage comes with risk.

Make sure that time is spent learning about the relationship between leverage and margin. Full understanding of how leverage effects margin may come through actual trading experience, so trading with low levels initially will limit risk to your capital. As trading experience develops, increase levels of leverage incrementally.

The level of leverage utilised will also depend on your chosen trading style. Day traders that place several trades a day will look to capital on the opportunity offered to make larger gains per trade. Longer term traders will use smaller levels of leverage as their gains will materialise over longer periods of time.

What ever level of leverage you chose to use, make sure to mitigate losses and protect your position by placing a stop loss order.

It is possible to trade without using leverage but is not easy, for two reasons:

Broker Requirement

Most brokers online brokers will require some form of leverage, but it can be small. There are brokers that offer no leverage trading and a simple search will help you find one. Alternatively, use a high street bank to change money and hold onto it until you want to change it back.

Profitability

Price fluctuations when Forex trading are measured in pips, the smallest measurable price movement is a single pip with a value of £0.0001. When trading without leverage, the gain or loss will be directly linked to the pip movement. if you trade £1,000 it will require £1,000 of capital investment and every pip change will have a value of £0.10. 

Trading without leverage therefore limits profitability and it will be extremely difficult to make any worthwhile gains, unless you are in a position to be able to invest tens of thousands or hundreds of thousands of pounds.

If limiting risk is the reason why trading without leverage is appealing, it may be more sensible to research and fully understand protecting your position with stop loss orders.

For more information on managing risk visit our managing risk hub.

Leverage is offered by brokers as incentive for traders use their trading platform. They appreciate that not every trader, particularly speculative traders, do not have the available funds to create the opportunity for worthwhile profits. The level of leverage offered by a broker can be a deciding factor for a trader when deciding which broker to use.

The other reason is that brokers make money on every trade placed by virtue of the spread. We go into this in more detail in our guide what is spread in forex trading but essentially spread is the broker commission fee, charged in the form of commission for placing a trade on the traders behalf.

Pip value increases as the level of leverage utilised gets bigger, therefore the broker earns more in commission.

This is perhaps the most commonly asked question when discussing leverage. When researching whether to use leverage of not to Forex trade, you will no doubt hear the phrase "double edged sword". This is because while trading with leverage can offer the potential for large gains that would otherwise not be available, it can also create increased risk if not managed correctly.

Trading Losses

Increasing the level of leverage utilised increases the value of every pip change in currency fluctuations. This means that if a small £1,000 account takes advantage of 100x leverage, the pip value could be as much as £10. This created the opportunity for large gains, but if the positions against the trader, losses are also increased at the same level.

Managed correctly with a stop loss order, the risk of incurring large losses can be mitigated. Visit our managing risk hub for more information.

Margin Requirement

Margin is an amount of money that a trader is required to deposit to the broker to take a position. Margin is usually calculated as a percentage of the total trade value, starting at around 3% for the smallest trades and tiered upwards. 

Leverage allows a trader to take large positions, this means a trader can take a position of 100x the equity in their account, increasing the total trade value.

It is important to remember that whilst it is an attractive to proposition to leverage a position, the margin requirements of the trade will increase inline with the upscaled position. As an example, if you take a position of 10,000 units and the margin requirement is 3%, the margin requirement will be £300, if you leverage your position to 100,000 units then the margin requirement will increase to £3,000.

The risk here is that if not enough useable margin is available, a traders account could be subject to a margin call.

Another commonly asked question but unfortunately one that is subjective. Traders should only trade with a level of leverage with which they are comfortable. If a trader is conservative and risk adverse, or are still learning how to trade the Forex markets, a lower level of leverage like 5:1 or 10:1 would be more appropriate than utilising higher levels. 

It may be a wiser approach to not worry about using leverage but instead research using it. There is no need to be afraid of leverage so long as you have knowledge of the risk and understand best practice on managing it.

To be clear, you can lose money when trading Forex markets whether you are trading with leverage or not! Using leverage increases the size of trading positions taken, consequently every fluctuation in price will result in high gains and losses.

In short, if price movement goes against the position taken, the trade will be in a loss. If the position is leveraged, the loss will be larger in proportion to the level of leverage taken.

Trading with leverage is necessary for most traders for a variety of reasons. If you are concerned about the risk involved, read our guide on using stop loss orders to learn how to protect your position by limiting exposure.