Friday, November 13, 2009

What is leverage?

The FOREX deals are accomplished in lots and each lot consists of 100,000 units of any particular foreign currency. To purchase one single lot of foreign exchange is required and that may run into hundreds of thousands of dollars which means the small investors are left out of the fray. For this very purpose the concept of leverage was introduced in the FOREX trade.

Leverage backed with credit, such as a margin account, is very common. Usually the leverage in the margined account is collateralized by the initial deposit made by you in that account. If the value of the trade goes down significantly, the broker may ask you to either deposit more cash, or sell a portion of your holding. Leverage, expressed as a ratio between total capital available to actual capital, is the amount of money a broker will lend you for trading. For example, a ratio of 100:1 means your broker would lend you $100 for every $1 of actual capital. Many brokerages offer as much as 250:1.

Margin requirements and interest vary among broker/dealers. The amount of leverage you use will depend on your broker and what you feel comfortable with. You can get leverage from a high as 1% with some brokers. This means you can control $100,000 with the investment of only $1,000. The broker sets a minimum account size also known as account margin or initial investment. Once you have deposited the required sum you will be able to trade in the FOREX market.