Forex trading, or FX trading as it is often called, involves the trading of one currency for another. Generally, you purchase one currency with another, hold the purchased currency until the exchange rate is favourable, and then exchange it back to the first currency. Forex trading software has opened up this investment option to individual investors and it has become quite popular recently. One thing that can make trading forex even more profitable is leverage.
Simply put, leverage is using debt to purchase an asset. The most common example would be a mortgage used to purchase a home. Since you’re not likely to have the entire purchase price of your home in savings, you put some money down and borrow the rest.
Leverage works the same way in trading. Leverage can magnify both gains and losses, so investors should have a well-designed trading strategy in place prior to using leveraged investing techniques. An example of using leverage would be using $10,000 of funds to trade $50,000 worth. In this case you are leveraged 5:1. If your currency transactions net a $100 profit, you would then realize $500.
But the same can work in reverse. If your currency moves against you for a $100 loss, you would realize a loss of $500. Your broker will require you to hold money in your account to cover potential losses, and this money is referred to as the margin.
Because leverage magnifies both profits and losses, it is usually recommended only for those traders who have completed some training and trades in the market already, and have a personalised trading strategy firmly in place. Applying leverage at that point can enhance your portfolio quicker than standard trading.