What does leverage mean in forex trading?

Answer 1

Leverage or gearing refers to how much capital (performance bond) the trader must put up to hold a contract (buy / sell position). The higher the available leverage, the smaller amount of up-front capital required to control the asset.

Take a house for example. Say the house costs $200,000. If you had all $200,000 liquid cash available, you could buy the house outright. This would be 1:1 leverage. $200,000 cost and $200,000 put down to pay for the cost.

200,000 / 200,000 = 1/1 or 1:1 leverage.

But let's say you do not h ave or do not wish to tie up $200k in the house. So you talk to a bank and they offer you amortgageloan with $20,000 down payment. The total cost is $200,000 but you only have to put up $20,000 to "control" the house. 20,000 / 200,000 = 1 / 10 or 1:10 leverage.

A similar concept holds in forex. to buy a standard lot contract of USDJPY ($100,000) would normally cost $100,000 for you to hold with 1:1 leverage. With 1:10 leverage, the trader would have to put up $10,000 to hold the $100k position. with 1:100 leverage, $1,000 is required per $100k.

Leverage gives the asset holder more buying power. It gives you the ability to manage assets that are valued much higher than the up-front capital required to purchase the asset outright.