The Basics of the Forex Market – Part 3

Part three of our Basics of the Forex Market is closely related to Part 2, which you can read here. We’re going to dive in to leverage, which is tightly connected to margin. What leverage does, is offer traders the ability to trade a bigger position than the size of their trading account would normally allow. Trading with leverage can increase the potential of your return on any given trade, but at the same time, it also increases the potential risk of a trade, meaning that your losses can also be significantly larger.

Say for example you have a forex trading account with $5,000 equity in it. By taking advantage of leverage, you’re able to open a much larger position than your $5,000 trading capital allows. With 100:1 leverage, you can open a position that’s 100x larger than your trading capital. To put this into perspective, if you want to open a $100,000 position in AUDUSD, with 100:1 leverage, you’d only need to use $1,000 of your trading equity as the required margin to open the trade.

Here’s how leverage and margin work together to increase your purchasing power:

Leverage          Margin              Buying Power

1:1                      $1,000               $1000
2:1                      $1,000               $2,000
50:1                    $1,000               $50,000
100:1                  $1,000               $100,000
200:1                  $1,000               $200,000

You get the drift.

The above table offers an indication of the maximum position sizes you can trade using various leverage options. As mentioned before, you really need to bear in mind the risks associated with trading on higher leverage. To get a feel for how it works, sign up for our demo MT4 account and you can trade virtual money until you get the hang of it.