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Many forex traders blow their accounts up and ultimately fail as traders because they do not understand two key concepts in the forex market: Leverage and Margin.

Leverage—Leverage is probably the one characteristic of the forex market that intrigues individual investors the most. Leverage is the ability to convert a small amount of power into a larger amount through the use of a tool. Imagine you are asked to move a large boulder from the spot where it is currently resting. You could certainly try to push and move the boulder with your bare hands, but your job will be much easier if you can use a tool—like a large pole—that you can place under the boulder that will give you some leverage.

The same principle holds true when you are investing in the forex market. You can make money by investing just your own money, but you can make much more money if you can use the tool of financial leverage by borrowing money from your dealer.

You can lever, or increase the investing power of, your forex accounts by using some of your own money to enter a trade and then borrowing the rest from your dealer. For example, if you have 100:1 leverage in the forex market, you can control $100,000 with as little as $1,000 of your own money. That means you only have to pay for 1 percent of the position with your own money. You can borrow the remaining 99 percent of the purchase price from your dealer.

Of course, some dealers offer leverage levels up to 400:1—which means you can control $400,000 with as little as $1,000 of your own money. While this may look appealing, don’t be fooled by the promise of potential profits higher levels of leverage offer. More likely than not, higher levels of leverage will destroy your account before they help it grow.

The leverage you enjoy in the forex market is determined by the margin you are required to post for each trade.

Margin—The forex market is an exciting market because your dealer is willing to lend you money so you increase your profit-generating potential in all of your trades. Before your dealer lets you borrow money, however, you have to show that you have some money to cover any losses you may incur. Margin is the money you set aside with your dealer for safe keeping to prove that you are able to cover your losses.

For example, if you want to buy the EUR/USD, you will be required to set aside one percent of the position size as margin. That means if the position size is $100,000, you will be required to set aside the equivalent of $1,000 to prove to your dealer that you can cover losses of at least $1,000 should your trade move against you.

Different currency pairs have different margin requirements. Major currency pairs have lower margin requirements because their high levels of liquidity make it easier to enter and exit your trades quickly—which gives your dealer added confidence it will be able to close out your positions without incurring unexpected losses. Exotic currency pairs have higher margin requirements because their low levels of liquidity make it harder to enter and exit your trades quickly.

Many beginning forex traders get confused by thinking that the money they set aside as margin actually goes toward purchasing currencies. It does not. You borrow 100 percent of the purchase price from your dealer. Your margin only shows your dealer you have money to cover any losses that you may incur.

When you buy a currency pair, you do not have to come up with the cash on your own. Your broker loans you enough of one currency to buy enough of the other currency in the pair. For example, if you click on the “Buy” button to buy the EUR/USD pair at 100,000 units, your dealer will loan you enough U.S. dollars (USD) to buy 100,000 euros (EUR). If the EUR/USD exchange rate is 1.4000 at the time, your dealer will loan you $140,000 to buy €100,000.

Make sure to watch the video above, and then continue to Short- vs. Long-term Trading

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fakunle sheriff  - good lesson   |2009-02-08 08:55:51 hi there, I will be pleased to read more of your teachings on forex trade/ Best regard

Jason  - Mathematical expression correct?   |2009-02-08 11:31:41 I don't know much if anything about all this, but according to the way the expression is written in #2.: You have Margin/Lot=Leverage or 1,000/100,000=100 or 100:1. The way I recall it expressed mathematically would be 1/100 or 1:100. I could be mistaken, maybe the colons and slashes are used differently in Forex. Or maybe I'm even wrong about math, it was a long time ago. I like the video. Do you have any on how Brokers cover their risk by taking positions opposite the retail client? I'd be interested to know any insights you have on how they are able to generate an internal market, allow spikes to occur without deviating from the current market price. Actually, anything you have on Brokers covering their risk would be nice.

Azeem  - Is leverage necessary?   |2009-07-07 16:30:27 ok it is well. but tell me that is there a way to not get any kind of leverage and just put my own money to buy full lot. i want to do that business with full of my money no matter how much it will require money... reply me Azeem

Farzy99   |2009-10-13 01:02:40 I am desperately looking for ans to a newbie question can soneone answer. My open balance =500 EUR USD 1.4635/40 = 5 pip spread Trade buy 1 mini lot =10000 Now, What is the lot size (0.1 or .01) What is my leverage What is my transaction cost What is margin req How much am I left after the first trade How much will be the margin call come

swadehansen  - Answers   |2009-10-13 01:26:03 Farzy99, First off, if you are trading somewhere that has a 5-pip spread on the EUR/USD, you may want to look for a less expensive dealer. Your transaction cost (so long as your dealer is not charging commissions) is equal to your spread. As soon as you enter your trade, your profit on the trade is -5 pips, and you have to overcome that before you will make a profit. The lot size will depend on how your dealer is set up. If your dealer uses full-size lots as the default, one mini lot will equal 0.1 full-size lots. If your dealer uses mini lots as the default, however, one mini lot will be 1.0. You will have to check with your dealer to see what leverage ratio you have in your account.

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