воскресенье, 27 мая 2018 г.

How does leverage work in the forex market


How does leverage work in the forex market?
The concept of leverage is used by both investors and companies. Investors use leverage to significantly increase the returns that can be provided on an investment. They lever their investments by using various instruments that include options, futures, and margin accounts. Companies can use leverage to finance their assets. In other words, instead of issuing stock to raise capital, companies can use debt financing to invest in business operations in an attempt to increase shareholder value. (For more insight, see What do people mean when they say that debt is a relatively cheaper form of finance than equity? )
In forex, investors use leverage to profit from the fluctuations in exchange rates between two different countries. The leverage that is achievable in the forex market is one of the highest that investors can obtain. Leverage is a loan that is provided to an investor by the broker that is handling the investor's or trader's forex account. When a trader decides to trade in the forex market, he or she must first open a margin account with a forex broker. Usually, the amount of leverage provided is either 50:1, 100:1 or 200:1, depending on the broker and the size of the position that the investor is trading. what does this mean? A 50:1 leverage ratio means that the minimum margin requirement for the trader is 1/50 = 2%. A 100:1 ratio means that the trader is required to have at least 1/100 = 1% of the total value of trade available as cash in the trading account, and so on. Standard trading is done on 100,000 units of currency, so for a trade of this size, the leverage provided is usually 50:1 or 100:1. Leverage of 200:1 is usually used for positions of $50,000 or less.
[When using leverage, it's important to use risk management techniques to limit losses. Many forms of risk management fall under the technical analysis umbrella. For example, stop-loss points may be set near support or resistance levels. Investopedia's Technical Analysis Course provides an in-depth overview of these concepts and others to help you become a successful trader.]
To trade $100,000 of currency, with a margin of 1%, an investor will only have to deposit $1,000 into his or her margin account. The leverage provided on a trade like this is 100:1. Leverage of this size is significantly larger than the 2:1 leverage commonly provided on equities and the 15:1 leverage provided in the futures market. Although 100:1 leverage may seem extremely risky, the risk is significantly less when you consider that currency prices usually change by less than 1% during intraday trading. If currencies fluctuated as much as equities, brokers would not be able to provide as much leverage.
Although the ability to earn significant profits by using leverage is substantial, leverage can also work against investors. For example, if the currency underlying one of your trades moves in the opposite direction of what you believed would happen, leverage will greatly amplify the potential losses. To avoid such a catastrophe, forex traders usually implement a strict trading style that includes the use of stop and limit orders.

How Leverage Is Used In Forex Trading.
“Leverage” in general terms simply means borrowed funds. Leverage is widely used not just to acquire physical assets like real estate or automobiles, but also to trade financial assets such as equities and foreign exchange (“forex”).
Forex trading by retail investors has grown by leaps and bounds in recent years, thanks to the proliferation of online trading platforms and the availability of cheap credit. The use of leverage in trading is often likened to a double-edged sword, since it magnifies gains and losses. This is more so in the case of forex trading, where high degrees of leverage are the norm. The examples in the next section illustrate how leverage magnifies returns for both profitable and unprofitable trades.
Let’s assume that you are an investor based in the U. S. and have an account with an online forex broker. Your broker provides you the maximum leverage permissible in the U. S. on major currency pairs of 50:1, which means that for every dollar you put up, you can trade $50 of a major currency. You put up $5,000 as margin, which is the collateral or equity in your trading account. This implies that you can put on a maximum of $250,000 ($5,000 x 50) in currency trading positions initially. This amount will obviously fluctuate depending on the profits or losses that you generate from trading. (To keep things simple, we ignore commissions, interest and other charges in these examples.)
Assume you initiated the above trade when the exchange rate was EUR 1 = USD 1.3600 (EUR/USD = 1.36), as you are bearish on the European currency and expect it to decline in the near term.
The 40% gain on your first leveraged forex trade has made you eager to do some more trading. You turn your attention to the Japanese yen (JPY), which is trading at 85 to the USD (USD/JPY = 85). You expect the yen to strengthen versus the USD, so you initiate a short USD / long yen position in the amount of USD 200,000. The success of your first trade has made you willing to trade a larger amount, since you now have USD 7,000 as margin in your account. While this is substantially larger than your first trade, you take comfort from the fact that you are still well within the maximum amount you could trade (based on 50:1 leverage) of USD 350,000.
Opening position: Short USD 200,000 USD 1 = JPY 85, i. e. + JPY 17 million.
Closing position: Triggering of stop-loss results in USD 200,000 short position covered USD 1 = JPY 87, i. e. – JPY 17.4 million.
The difference of JPY 400,000 is your net loss, which at an exchange rate of 87, works out to USD 4,597.70.
While the prospect of generating big profits without putting down too much of your own money may be a tempting one, always keep in mind that an excessively high degree of leverage could result in you losing your shirt and much more. A few safety precautions used by professional traders may help mitigate the inherent risks of leveraged forex trading:
Cap Your Losses : If you hope to take big profits someday, you must first learn how to keep your losses small. Cap your losses to within manageable limits before they get out of hand and drastically erode your equity. Use Strategic Stops : Strategic stops are of utmost importance in the around-the-clock forex market, where you can go to bed and wake up the next day to discover that your position has been adversely affected by a move of a couple hundred pips. Stops can be used not just to ensure that losses are capped, but also to protect profits. Don’t Get In Over Your Head : Do not try to get out from a losing position by doubling down or averaging down on it. The biggest trading losses have occurred because a rogue trader stuck to his guns and kept adding to a losing position until it became so large, it had to be unwound at a catastrophic loss. The trader’s view may eventually have been right, but it was generally too late to redeem the situation. It's far better to cut your losses and keep your account alive to trade another day, than to be left hoping for an unlikely miracle that will reverse a huge loss. Use Leverage Appropriate to Your Comfort Level : Using 50:1 leverage means that a 2% adverse move could wipe out all your equity or margin. If you are a relatively cautious investor or trader, use a lower level of leverage that you are comfortable with, perhaps 5:1 or 10:1.
While the high degree of leverage inherent in forex trading magnifies returns and risks, using a few safety precautions used by professional traders may help mitigate these risks.

How does leverage work in the forex market


Latest update December 20th, 2017 2:06 PM.
What is leverage and how does it work in the Forex market?
This widely used idiom may apply to some things in life, but certainly NOT when it comes to leverage! Quite literally, the MORE you know the BETTER!
What is leverage?
Leverage essentially means having the ability to control a large sum of capital using very little of your own funds and borrowing the rest. When you buy a house on credit i. e. a mortgage, for example, you are actually trading with leverage. Say you put a 25% down payment of $50,000 on a house worth $200,000, you are effectively using leverage here!
Leverage in the forex market is rather straightforward. For every $1 in your account you can control $X amount where X is greater than 1. For instance, 100:1 leverage means you control $100 for each $1 in your account. If you have $1,000 in your account this means that you can control $100,000 in positions.
The leverage achievable in the forex market, nonetheless, is immense in comparison to other markets. In the stock market, for example, the majority of leveraged accounts allows you to borrow at a 2:1 ratio i. e. a $10,000 deposit allows you to control $20,000. In forex, leverage of 500:1 is possible!
How does one use leverage?
This is always best explained using an example:
Terry the investor believes the EUR will strengthen against the US dollar in the coming months. He calculates his position size and wants to take a $100k position at (one standard lot) in the EUR/USD market at leverage of 100:1. Terry’s current account balance stands at $10,000. The broker, assuming that the margin rate is 1%, would set aside $1,000 from the account (1% of 100,000 is 1000), thus leaving Terry with a usable free margin of $9000.
Why is there a margin rate and what the heck is free usable margin?
In a margin account, the broker uses the $1,000 as security. If Terry’s position worsens or his losses exceed $9,000, the account will be trading at the margin level ($1,000). If this occurs, the broker will issue the dreaded margin call.
Free usable margin is the amount of account equity that is not currently being used to maintain the open position. Essentially, it is the amount available in the account to open additional positions, and the amount that the current position can move against Terry before receiving a margin call.
As you can see, margin is not a fee nor is it a transaction cost. If you buy on margin you’re, in essence, borrowing money from your broker to trade. The deposit is considered margin which is required in order to use leverage.
Margin requirements differ from broker to broker. IC Markets offer very reasonable margin rates as low as 0.2% on most FX pairs, as well as flexible leverage options ranging from 1:1 to 1:500. With margin rates set at 0.2%, instead of $1000 margin being required as we saw in Terry’s trade example above, the amount needed would have been $200 – quite a difference!
How much leverage should I use?
This is a common question and it really depends on the risk taken on a trade. Let’s assume that you have a $5000 account and you risk 2% on each trade.
Let’s also assume that you want to buy the EUR/USD at 1.1256, and have a stop set at 1.1246: a 10-pip stop loss. To trade this position, one would be required to enter using one standard lot, or $100,000. That’s twenty times your account size you’re trading there. However, by correctly sizing your position, you only have 2% of your account equity at risk even though you have a $100k position in the market.
Let’s take this a step further and assume you wanted to risk 10% of your account on the same trade discussed above. This would equate to $500 of risk. To trade with a 10-pip stop, you’d then need to input five standard lots, or $500,000. Now, you’re trading at leverage of 100:1 – 100 times your account size, but only risking 10%.
For beginner traders, we would strongly advise respecting leverage as it truly is a double-edged sword. Trade small to begin with and please RESPECT leverage!
IC Markets.
IC Markets is revolutionizing on-line forex trading; on-line traders are now able to gain access to pricing and liquidity previously only available to investment banks and high net worth individuals.

Forex leverage: How it works, why it's dangerous.
Currency traders around the world are still reeling from the effects of the Swiss National Bank's surprise move to ditch its efforts at pegging the value of Swiss francs to euros.
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For three years, the SNB had used its own war chest to make sure that a euro was worth 1.20 Swiss francs. After giving up on trying to artificially keep the euro strong and franc weak, the value of euros plummeted, thus wreaking havoc on global currency markets.
And it wasn't just large banks, hedge funds and corporations that felt the pain but also smaller traders and investors, as well.
Over the past decade or so, the world of foreign exchange trading has seen the emergence of brokerages that cater to retail, or smaller traders. While the accessibility to global currency markets had been reserved for just professionals, or larger institutions, retail forex brokerages allowed up-and-coming traders with limited financial resources to participate in the market.
However, the risks that kept the market "off limits" for the smaller folks came roaring back with a vengeance over the last couple of days.
The SNB's action to remove its currency peg pushed the value of euros relative to Swiss francs off a cliff, and allowed no real time for anyone to react, or manage trading risks in a traditional manner.
The economic impact, in terms of losses, is much greater from a corporate or institutional standpoint. However, many retail traders found their trading accounts completely wiped out, being on the wrong side of a trade that couldn't be liquidated fast enough to preserve their capital. Trading in currency markets at the retail level, with these types of brokerages, centers on the use of one of the biggest double-edged swords in financial markets: leverage.
In other words, borrowed funds that are used to amplify potential returns but can also exacerbate the potential losses of trading positions. In the world of retail foreign exchange trading, use of leverage is key.
Here's how it works:
Let's say you want to take a $10,000 position in terms of Swiss francs. Under current regulatory guidelines in the U. S., you are mandated to keep at least $200 in your account in order to support that position. That's because there's a mandated minimum margin requirement of 2 percent for retail forex markets.
In other words, you can only have a position that's 50 times greater than the equity in your margin account.
If the value of your position grows because of market movements, there is no issue. But if your position loses value to a point where you no longer meet minimum margin requirements, your broker will liquidate assets to help assure that you don't lose more money than you put into the account.
The reason why some retail foreign exchange brokerages have gone bankrupt, and others are in severe distress, has to do with how those margin accounts were maintained during the SNB's shock move. Certain accounts with losing positions weren't able to be liquidated quickly enough before they went into deficit. That left some brokers responsible for the debit balances in client margin accounts. If those debit balances were high enough, that could cripple the capital position of these retail brokerages.
At that point, a handful of things can happen.
For one, the broker can request the client to add enough funds to bring their account back into good standing. Or, the broker is left holding the bag on client losses, perhaps with only legal recourse to try to recover those losses.
According to Forex, which is a retail foreign exchange broker and is owned by publicly traded Gain Capital, the company does "reserve the right to hold clients responsible for large debit balances and in special circumstances." Its website also encourages clients to manage use of leverage carefully, since use of more leverage increases risk.
Bottom line, the pain of the SNB's removal of its currency peg hit numerous parts of the market, and will lead to outsized financial losses for the big guys and the little guys. On a relative basis, retail traders may feel more pain than their bigger counterparts.
The recent market action serves as a potent reminder of just how dangerous leverage can be when price action moves swiftly, and without warning.

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