Leverage is effectively a loan from a broker for traders to enter larger positions. Leverage is very risky.
Leverage is a function that increases a traders’ buying power allowing them to open larger positions than their account balance would otherwise allow. For example, if you wanted to trade 100,000 EUR/USD without leverage, you’d need €100,000. Whereas if you had 1:30 leverage from your broker, you’d need to provide €3,333.33 leverage to open the position.
Leverage is effectively a loan for the sole purpose of providing traders with the ability to get greater exposure to financial products.
Leverage is usually expressed as a ratio, such as 1:30. Leverage earns its name from the notion that it acts as a lever, meaning with less capital, you can open larger positions.
Suppose you’re trading with 1:30 leverage. It means that you can get 30 dollars of exposure for every dollar you have available. With 1:200 leverage, you would get 200 dollars of exposure to the market with one dollar of margin.
The table below shows how different leverage settings impact margin requirements when opening a 100,000 USD/CHF position.
As leverage lets you get larger exposure to the market, it can lead to rapid losses if used irresponsibly. Just because leverage allows you to open larger positions doesn’t mean you should. Small trading accounts can’t sustain the losses of large trades.
Imagine having an account balance of $1,000 and trading with 1:1000 leverage. Theoretically, you could open a position of 2 lots of USD/CHF. The margin required will be $200. Suppose the market moves against your position by 20 pips; that’s an unrealised loss of CH₣400 (approx. $433). A 20 pip price movement can happen abruptly and can quickly lead to a stop out and the loss of most of your balance.