Financial leverage (or leverage) is one of the most used financial instruments in trading, thanks to which a trader buys or sells financial assets (stocks, commodities, currencies) for an amount greater than the capital held and, consequently, benefits from this multiplier effect to increase his earnings. In Forex markets, leverage is used to buy currencies.
Forex brokers makes the capital available to traders who do not initially have, offering the financial leverage service. For example, in the case of 1:50 or leverage one-to-fifty, a trader can perform a transaction to buy a currency for, let’s say, € 10,000, having only a capital of € 200, or 10,000 / 200, which gives a leverage of 50. The remaining € 9,800 are made available by the broker. In the case of a leverage 1:100, the transaction can be made with only € 100, or 10,000 / 100, with a leverage of 100. And so on. The greater the leverage, the lower the initial capital required to carry out an operation.
Suppose now that the euro appreciates + 1.0%, and that a trader is operating with a leverage of 50. He will earn € 100, thus obtaining a final capital of 10,100. If he had not had the leverage offered by the broker, the trader could have invested only € 200, earning only € 2 from the appreciation of the currency. This is exactly the advantage of the leverage effect, which is comparable in all respects to a loan that the broker grants to a customer and which allows him to multiply the gains if the market goes in the desired direction.
It must be said that, as the trader can earn, he can also lose in the same way, if the currency depreciates. Therefore, the leverage allows the trader to gain higher profits, thanks to the broker that gives him the possibility to negotiate large positions, using only a small percentage of the value as an initial deposit but has the side effect that, as profits are enlarged, the same happens for losses. A trader could therefore lose much more than the initial deposit if the market goes wrong.
For this reason, brokers require a margin level, which is an initial deposit needed to keep orders open on the broker account. To open and keep an order open, a trader must have enough liquidity to cover the margin for the entire trading time. The available margin represents the amount of capital that remains to place new orders or cover any negative price movement in open orders.