Understanding Leverage

[The Aslan Group]

I have found that the concept of leverage is quite confusing for many traders and I'd like to give a practical example of how it works.

Your degree of leverage ( 50:1, 200:1, 500:1 etc ) determines the amount of equity you must have in your account to open/maintain a trade.

Suppose you have a $5,000 account and opened 1 lot of the EUR/USD...

If your leverage was 50:1 this trade would require $2,000 in margin meaning you would have $3,000 left in “free margin”.

If your leverage was 100:1 this trade would require $1,000 in margin leaving you $4,000 in free margin.

If your leverage was 200:1 this trade would require $500 in margin leaving you $4,500 in free margin.

If your leverage was 500:1 this trade would require only $200 in margin.

The leverage has no real bearing on the trade itself…a 10 pip loss on a 50:1 account is going to equal $100 just the same as it would in a 500:1 account.

The difference is that you could technically open 5 lots in a 500:1 account and only require $1,000 in margin, while you would require $10,000 in margin to do that in a 50:1 account.

Just because the leverage is there however, does not mean you have to use it. It’s kind of like having a high limit on your credit card…it could come in handy on a rare occasion but to access it frequently can be very dangerous to your financial well being.

Best Regards,

Gavin

[raa]

I just want to add that without any contradiction with a sound money management high leverage allow you to keep only small part of your funds at brokers account but trade out of a total amount.