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What is Leverage?

By , Head Forex Trading Instructor
07 February 2012 15:50 GMT

Previous: The Long and Short of It

Leverage is a financial tool that allows an individual to increase their market exposure to a point that exceeds their actual investment. For example, a trader goes long 10000 units of the USD/JPY, with $1,000 dollars of equity in their account.

The USD/JPY trade is equivalent to controlling $10,000. Because the trade is 10 times larger than the equity in the trader’s account, the account is said to be leveraged 10 times or 10:1.

What_is_Leverage_body_Picture_2.png, What is Leverage?

Had the trader bought 20,000 units of the USD/JPY, which is equivalent to $20,000, their account would have been leveraged 20:1.

What_is_Leverage_body_Picture_1.png, What is Leverage?

Leverage allows an individual to control larger trade sizes. Traders will use this tool as a way to magnify their returns. It’s imperative to stress, that losses are also magnified when leverage is used. Therefore, it is important to understand that leverage needs to be controlled.

FXCM provides flexible leverage to its clients. You can trade with no leverage at all, or you can trade with a significant amount of leverage.

FXCM believes clients have a greater chance of long-term success when a conservative amount of leverage, or even no leverage, is implemented.

Here is a recent study completed of thousands of FXCM accounts (“Traits of Successful Traders: How Much Capital Should I Trade Forex With?”). What we found out is that when traders used more conservative amounts of effective leverage, the percentage of profitable traders increased. Traders should look to use effective leverage of 10 to 1 or less.

Next: How to Determine Effective Leverage

---Written by Jeremy Wagner, Lead Trading Instructor, DailyFX Education

To contact Jeremy, email jwagner@dailyfx.com. Follow me on Twitter at @JWagnerFXTrader.

To be added to Jeremy’s e-mail distribution list, send an email with the subject line “Distribution List” to jwagner@dailyfx.com.

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07 February 2012 15:50 GMT