If If you’ve been following the news recently you might have heard that globally there is an economic recession underway due to COVID-19. Understanding Leverage It is a concept that is discussed quite often for its merits and offered prospects, but rarely for the risks involved. In this article we are aiming to provide the reader with a comprehensive view of leverage including all that’s good as well as all that’s bad. Let’s start at the start.
Leverage defined In trading, it is possible to borrow money from your broker to trade bigger positions. This means that if you are trading a standard lot of USD, you don’t need to have 100,000 USD in your trading account. Taking 1:100 leverage would require you to actually use only 1000 USD from your account. The rest is leveraged. The ratio 1:100 means that with 1 unit of a currency in your trading account, you can hold 100. The ratio goes up to 1:500. Different brokers have their own rules. Remember that the leveraged amount actually is only in the numbers. Eventually your profit or loss is what is added to or taken from your account, the rest is just numbers on a screen.
So, leverage is virtual credit. Essentially then leverage allows a trader to use external capital against their invested capital.
Why is it important? There are two main reasons:
⦁ It allows people to trade in a market that would have otherwise been inaccessible.
⦁ It maximizes profits as the price fluctuation in a day is not too big.
Without leverage the average day trader could not have traded on a regular basis, and certainly not for the incentive of a 1% profit (which is what the average increase or decrease per day is for a currency).