Leverage is a powerful tool for Forex traders, and it’s one of the most important components of any trading strategy. The right amount of leverage can significantly increase your chances of making a profit. But, the wrong amount can get you into trouble.
And in this post, we’ll share the right amount of leverage for different Forex trading strategies. We’ll also explain how to calculate your risk-to-reward ratio when trading with leverage.
So, if you’re looking for the right balance between risk and reward when trading, read on.
What is Forex Trading?
Forex trading is when a trader buys a currency and sells a different one, and the exchange range fluctuates according to the demand and supply. The trade for currencies takes place in the foreign exchange market that is open from Monday to Friday.
The Foreign exchange market is open 24 hours a day. All currencies are traded over the counter (OTC), which means there are no physical exchanges, and a worldwide network of financial institutions and banks oversee the operations. As a result, the vast majority of trading in the market is between institutional traders.
Leverage in Forex Trading
In the past, only large financial institutions and wealthy individuals were allowed to invest in the Forex market. The main reason for this was a large amount of capital to be invested by the trader. Retail traders usually lacked large capital, which is why they were unable to invest in Forex.
What Leverage Level is the Safest?
With a Lot of 100,000 USD:
| Leverage | Change in currency pairs % | Position size in lots | MarginUSD | Balance, Change % |
| 1:100 | 1% | 1 | 1000 | 100% |
| 1:50 | 1% | 1 | 2000 | 50% |
| 1:33 | 1% | 1 | 3000 | 33% |
| 1:20 | 1% | 1 | 5000 | 20% |
| 1:10 | 1% | 1 | 10000 | 10% |
| 1:5 | 1% | 1 | 20000 | 5% |
| 1:3 | 1% | 1 | 33000 | 3% |
| 1:1 | 1% | 1 | 100000 | 1% |
Initial Investment of 1000 dollars (Risk and Drawdown of 1 %) :
| Leverage | % of Position Drawdown | Maximum No. of Positions | BalanceUSD | Risk of Account per Position % |
| 1:100 | 1% | 100 | 1000 | 0.01% |
| 1:50 | 1% | 50 | 1000 | 0.02% |
| 1:33 | 1% | 33 | 1000 | 0.03% |
| 1:20 | 1% | 20 | 1000 | 0.05% |
| 1:10 | 1% | 10 | 1000 | 0.10% |
| 1:5 | 1% | 5 | 1000 | 0.20% |
| 1:3 | 1% | 3 | 1000 | 0.33% |
| 1:1 | 1% | 1 | 1000 | 1.00% |
Leverage Ratio in Forex Trading
In the Forex market, leverage is the total amount of trading funds that the broker is willing to lend to the trader’s Investment based on the ratio of credit funds to capital. The amount of leverage that a broker provides is inconsistent; in some cases, the standard leverage rate that brokers ask is 1:100 or more.
The leverage used in the Forex market is expressed as a ratio, which means that if you have one-dollar equity, you can initially invest 100 dollars.
Leverage Ratio that is good for Beginners
New traders are usually attracted to the leverage-based earning strategy, as they want to make profits in the short term. However, there are risks associated with leverage, so beginners must have a thorough grasp of the following concepts:
- Equity and balance of the trading account
- Free margin
- Margin
- Account-level
- Stop out
- Margin call out
Why is Leverage Required in Forex Trading?
Due to the internet and other means, it is easy to access the Forex markets nowadays for traders. As a result, the daily trading value at Forex has also increased significantly over the past ten years. As a result, it has also increased the total number of retail traders in the market.
The availability of derivatives, such as CFDs (Contract for differences), allows traders to speculate the rise or fall in the value of currencies without owning the underlying asset. Leverage in the Forex market is important for derivative trading, as it allows traders to enter the market with a small capital amount.
For example, if a trader needs 100,000 dollars to enter the market with leverage, the amount can fall to just 1,000 dollars. Leverage has allowed all types of investors who previously couldn’t invest in the Forex market to enter the market.
How Does Leverage Work in the Forex Market?
Leverage in financial terms is expressed as a ratio (1: 1, 1: 10, 1: 100). The amount of leverage and the size of the initial Investment by the trader determine the size of trade they will control. For example, if a trader initially invests 1,000 dollars, the levels of leverage will have a varying effect on the size of the trade.
| Leverage | Size of Trade |
| 1:1 (no leverage) | 1,000 dollars |
| 1:5 | 5,000 dollars |
| 1:10 | 10,000 dollars |
| 1:20 | 20,000 dollars |
| 1:50 | 50,000 dollars |
| 1:100 | 100,000 dollars |
As you can see in the table, the higher the leverage in play, the larger the trade size for the trader. Thus, even though using leverage has several positives, it is still a risky move for the trader. To understand how leverage can lead to losses and profits, traders must understand margin, and we have discussed the concept below.
Margin
Margin is the deposit the trader needs to pay to use leverage in the Forex market. This amount should already be present in the trader’s account and be reserved once they open a trade using financial leverage. The amount of the margin that is required depends on the trade and the leverage.
For a standard lot, which is 100,000 dollars, the required margin will change. Please study the table below:
| Leverage | Required Margin |
| 1:1 | 100 % |
| 1:5 | 20 % |
| 1:10 | 10 % |
| 1:20 | 5 % |
| 1:50 | 2 % |
| 1:100 | 1 % |
As you can see in the table, the higher the leverage, the lower the margin required for a trader to enter the market. So, if a trader wishes to open a market position of one standard lot (100,000 dollars) using leverage (1:50), a deposit of 2,000 dollars would need to be paid as the margin.
Pros and Cons of Leverage in the Forex Market
As we have already discussed, leverage has many benefits for retail traders in the Forex market, especially for those traders that don’t have much capital to invest. However, even though leverage can increase profits, it comes with risks and huge losses for the trader.
Traders that enter the Forex market low on capital and overleveraged can see their Investment vanish if there are fluctuations in the market. The margin needed for financial leverage can also eat up the Investment if the trader opts for high financial leverage and invests only a small percentage of the total capital. If a trader is stuck in this scenario, it is a dangerous position, as if the market moves in a negative trajectory, the trader will lose all the Investment. Therefore, it is important for traders entering the Forex market to be cautious and understand margin and leverage thoroughly.
New traders should also have prior knowledge of how the Forex market works before they invest. Some traders also implement a sound risk strategy, which is leverage based on the capital available.
Experts advise new traders to start with a demo account before investing their own money, enabling them to understand the market without risks better.
Conclusion
We have discussed in this article what leverage is and how traders can use it for their benefit. We have also discussed the pros and cons of leverage and that there are times when it is not appropriate to use leverage.
However, the crux of this article is the information we have shared regarding the safest levels of leverage. Traders looking to use leverage must go through all the details, assess the risks, and then decide.