The Forex market typically trades in big numbers. The unit of trading here is one contract which is equivalent to $100,000. You may well question the ability of a small time retail trader to keep up with such high company. But, Forex market has an answer to this dilemma in the form of leverage.
Leverage is one of the most useful, attractive and practical tools that allow traders to be competitive and relevant in their trading. Leverage is offered to the traders by the Forex brokers who operate trading platforms. The ratio of leverage offered can vary and can be anything like 400:1 or more depending on the broker and the margin deposit placed by the trader.
Leverage becomes a necessity for traders in the Forex market as the price movements happen in very small doses. Due to this leverage is used to enhance the profits. Leverage takes the form of a loan that the trader borrows from the broker. Like any other loan there is interest levied on the leverage and this is generally set off against the interest earned on the profits.
The Forex broker offers the trader leverage based on the amount in his margin deposit. The ratio here can be anything and thus we see leverage of different ratios. For instance, if the leverage afforded to the trader is 200:1 and if he made an initial deposit or margin deposit of $100 with leverage it will go up to $100 x 200=$20,000. The profits of the trade will be calculated for $20,000 if you traded with that amount and the losses will also be calculated the same way.
There are three types of accounts a Forex broker offers. One is a mini account where traders are able to start out with a margin deposit of a few hundred dollars. The second type of account is where traders have a standard margin deposit for which the minimum requirement is $2000. Then there are the premium accounts for the traders who are willing to invest at a higher level.
Traders enter into agreements with Forex brokers about the leverage offered for investing in the Forex market. The borrowed capital or what is called as the leverage is what the trader will be investing and on what the profits and losses of the trade will be calculated. Apart from this, the interest on the loan and the profits will be calculated on the amount invested. A trader must remember to strike a good balance between his investments and his account so that he can keep trading in the future.