Wednesday, October 12, 2005 6:29 PM

Platforms that offer forex trading give traders the ability to leverage their positions up to 500:1. What does this mean, how does it work, and how can they do this?

1. Platforms make money from the spread. Their goal is volume. Leverage increases their profit. For example if you have 1,000 in your account and purchase a 1k lot of EUR/USD on a 3 pip spread they will have a profit of $.03 . However if they allow you to purchase a 10k lot of EUR/USD their profit will be $3. So it is in the benefit of the platforms

2. Leverage is not like margin. The forex market changes very little in % terms, so without leverage, it is difficult to make a significant amount of money.

Leverage also allows you to take MULTIPLE positions. Those positions might be opposite of each other, thus increasing your position size but NOT your risk or currency exposure. For example, if you have a 10x leverage EUR/USD long and a 10x leverage USD/CHF short - you are NET FLAT minus the spread.

So it does not necessarily mean you will take a larger position, but that you can have many positions.

A Margin Based System

Currency trading used to be an investment for wealthy investors. Ordinary investors could only envy the returns made from the currency hedge fund managers. However, due to the advent of the internet and prevalence of online trading, currency trading has become more and more popular. Today, foreign exchange trading is no longer only available to the wealthiest through the big investment banks. Futures commercial merchants approved by CFTC are also able to offer foreign exchange as a product to everyday investors at an affordable level. Thanks to the invention of leverage and margin trading system, investors can trade much bigger contract size with a fraction amount of deposits required.

Increase Your Buying Power

Leverage is the use of various financial instruments or borrowed capital, such as margin, to increase the potential return of an investment. Many traders consider leverage dangerous because traders add bigger position sizes without actually owning them. Nevertheless, leverage is an exceptionally good tool that can be utilized to increase your buying power as long as trader has a risk management plan associated with it. Some seasoned currency trader harness leverage effectively in currency trading. They apply small leverage to test the market sentiment. Once the strategy works with small position size and leverage, they then multiply leverage quickly to maximize profit potentials.

How it Works

For Example: in order to trade 100,000 units of USD/JPY. Traditionally, trader needs 100,000 US dollars or we say 1:1 leverage (trading cash). However, with 100:1 leverage, currency trader is only required to deposit 1/100th of the amount needed, 1,000 US dollars.