Leverage in the layman’s terms is the loan that investors get from the brokers when they
are investing in the foreign exchange trading market. When it comes to the functioning of
trading markets, the forex market is a bit different in comparison to the equities market.
This is because the volatility is low in absolute terms when you are comparing the forex
market with the equities market. So while it is quite possible to see a 20% to 30% shift in
intraday trading in the equities or sometimes even futures markets, you wouldn’t get to see
more than 1% movement in the foreign exchange market. That is also largely because in
case of currency pairs, a 1-cent move is considered a big change.

This is where leverage becomes important and it makes it possible for investors to hold
positions much bigger in size than the deposit that they have paid with the broker. For
example, by paying a deposit of just $1000, the investor can still have positions worth
$100,000 which is a 100:1 ratio. That is forex leverage explained for you and that is what
gives forex traders to multiply their investment exponentially and make huge gains.

However, leverage is considered to be a double edged sword. Forex lots could become
important here and forex traders should understand a lot more about the working of pip
spreads. If the traders don’t get their spreads correctly and the combination of lot sizes,
number of lots and pips correctly, the loss could be magnified as well. In the end, the
ease with which you can leverage and try to make money out of your positions without
completely paying for them is similar to the risk which is present. When you are leveraging
a position, you give collateral but brokers often allow you to trade much higher than that.

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