What is the leverage in forex?

A lot of you might have heard about forex leverage. 

But what is leverage in forex exactly?

In this article we’ll explain everything you need to know about it, and why it’s such an important tool.

Let’s get started:

 

Forex leverage is a tool which multiplies the value of money invested in a position. It allows traders to move big capitals with a very small investment.

That’s why Forex trading is known to be one financial instrument which allows many people to trade.

For instance, if a trader starts trading with only $100, thanks to the leverage, they can move a bigger amount of capitals. As a result they’ll have the opportunity to make larger profits and open more positions.

However, it’s very important to mention that the forex leverage is a doubled-edged sword.

Why?

The reason is very simple: if it can multiply the winnings, it can also multiply the potential losses.

To understand this concept better just think about a $10 investment in EUR/USD with a 1:100 leverage. If that trade goes well the potential profit could be $1000, but the same multiplication must be applied to calculate the potential losses too.

Let’s understand what is leverage in Forex with an example:

 

Example of forex leverage

Imagine you have a trading account with the selected forex leverage of 1:200.

Investing just $100 allows you to move in the market a total amount of $20.000.

Why? Because you multiply 200 times the $100 invested.

This example shows why fx trading is so popular. It’s possible to earn big profits from a very small amount of money.

 

Different Types of Forex Leverage

The Forex leverage type can change based on which country you live. For instance if you live in Europe or the United Kingdom then the rules change a bit.

That’s due to a new ruling that came into force in 2018 from the European Securities and Market Authorities body (ESMA).

The new Esma regulation in Forex trading was introduced to protect traders from high risk losses. So now every Forex broker licensed in Europe must apply a maximum leverage of 1:30 for their European clients.

For traders who live outside Europe, the maximum leverage doesn’t have such a strict limit. The maximum amount is set by each broker.

Normally brokers outside of Europe will offer a maximum leverage up to 1:400 or 1:500.

 

 

Example of Forex leverage and their purchase power

After you’ve opened a Forex trading account with a broker, you’ll be able to start trading. From here you can choose your leverage amount when opening positions.

However, with some brokers, it can be set differently for each position a trader opens.

To see the different leverage offers, please see our best forex brokers page.

One way you can minimise the risk of trading losses is to educate yourself about how Forex works. Sometime people lose profits due to a lack of experience or strategy, that’s why we’d recommend you practice trading with a Forex demo account.

A Forex demo account is a good way to test a broker’s platform and practice trading. Most brokers will provide a free demo account for new clients. The demo version comes with all the same features as the real version, plus an amount of virtual funds for you to ‘spend’.

Most importantly a demo account will let you open a practice trade where you can select the leverage amount.

 

Leverage in Forex before the new ESMA regulation

When Forex trading first emerged online, each broker could decide themselves the maximum leverage to offer to their clients.

Most of the brokers were offering a ratio from 1:300 to 1:500. This enabled many traders to start investing and open positions with small amounts of money.

Since 2018 the European authorities (ESMA) decided to introduce a new regulation limiting the leverage amount. This was designed as a way to prevent people from losing too much of their money. ESMA were monitoring Forex trading market for years, and they decided it was time to focus on investor protection more.

This is the reason why the new regulation has been introduced.

 

What is leverage in Forex in 2020?

As we’ve mentioned briefly, since July 2018 the maximum forex leverage available for European trader is 1:30. That is the highest amount that European licenced trading platforms can offer for the main currency pairs.

The leverage for cryptocurrencies is up to 1:5, and for other currency pairs, indexes and commodities it ranges from 1:10 to 1:20.

This is a regulation which applies to all European trading platforms, and is only for European clients.

If you’re a trader residing in America, Africa, Asia or Oceania, this regulation does not apply.

 

Conclusion

The concept of leverage in Forex can be difficult for many traders to understand, especially for beginners.

The main point to remember that it’s a multiplier tool that can help you make bigger profits. It’s just important that the tool is used wisely to get the most benefits out of it.

It can be a dangerous tool for not very experienced traders. So remember that experience and restraint is key to using it well.

We’d also recommend that you get to know the leverage offered by your selected broker as this will give you a good idea of how to manage it.

Finally, at the end of this article hopefully we have answered your question: “what is leverage in forex”.