Understanding leverage and margin in Forex trading

Ever wanted to trade with more money than you actually have? In forex, that's possible thanks to leverage. It allows you to control a larger portion of the market with a smaller investment. However, while leverage in forex trading can amplify your potential profits, it also increases your risks. 

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What is leverage? Your trading amplifier

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Think of leverage as a magnifying glass. It takes your initial stake (your "margin") and amplifies it, giving you more buying power. This lets you potentially make bigger profits but also exposes you to bigger losses.

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Let's say you have $100 to trade. With a leverage of 1:100, you can actually control $10,000 worth of currency. It's like being able to lift ten times your own weight! But remember, if that weight comes crashing down, it'll hurt a lot more.

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Imagine you want to buy 10 shares of a stock that cost $160 each. That's $1,600 total. But with a leverage of 1:10, you could buy those same 10 shares for just $160 of your own money.

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• If the stock price goes up by $40: You'd make a $400 profit, whether you used leverage or not. But your return on investment (ROI) would be way higher with leverage.
• If the stock price goes down by $20: You'd lose $200, again, regardless of leverage. But with leverage, that loss represents a much bigger chunk of your initial investment.

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What is margin? Your security deposit

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To use leverage, you need to put down a deposit called margin. It's like a safety net for the broker, ensuring you have enough money to cover potential losses. The amount of margin you need depends on the leverage you use and the size of your trade.

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Types of margin: Used vs. free margin

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Your trading account will show you two types of margin:

• Used margin: This is the amount of money currently tied up in your open trades.
• Free margin: This is the money you have available to open new trades.

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Margin call: A warning signal

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If your losses get too big, your margin level (the ratio of your equity to used margin) can drop too low. If that happens, your broker may issue a margin call, which means you’ll need to add more funds or risk having your trades closed. To avoid this, you can calculate your margin using online margin calculators.

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The takeaway: Leverage with caution

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Leverage can be a powerful tool, but it's also risky. It's like driving a sports car – fun and fast, but it requires skill and caution to handle. Always do your research, start with small trades, and never risk more than you can afford to lose.

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Before you start using leverage, take the time to learn about it in our free forex courses on Deriv Academy or practice with a demo account. Once you're confident, you can start harnessing its power to potentially increase your trading profits.

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Log in to Deriv Academy using your Deriv account email and password to get started.