What Is Leverage In Forex And How Does It Work?

It seems that every day the stock market is becoming more challenging for the retail investor to participate in, with increased volatility, wild swings and violent down days becoming the normal. And yet on top of that, we are seeing historically high prices which are simply increasing the risk of participation and reducing the potential rewards at the same time, making it harder than ever for most investors to meet their goals.

This weekend past, I had the pleasure of teaching a brand-new two-day class in the Online Trading Academy Tampa location entitled Trading for Income. As well as discussing the Online Trading Academy core strategy, we looked at alternative investments to stocks to make our money work harder and increase potential returns. The lessons quickly turned to the world of Forex trading and the power this market offers in the form of leverage. Leverage is a powerful tool when used responsibly, but also comes with risks if abused.

Most people are used to paying cash prices for their stocks and assets. For example, if I had $500 in my investing account and I wanted to purchase as many shares as possible of a $50 stock, I would be able to purchase 10 shares in total using the cash I had (10 x $50 = $500). Obviously, the more cash you have, the more shares you can buy. This is a highly limiting factor for those with lower account balances but also limits purchase power of those with higher sums of principal too.

What Is Leverage?

In trading and investing, the term leverage is used to describe when a speculator uses a small amount of money to control a larger amount. To be able to use leverage, you need to apply for a margin account for your trading. In a margin account, the broker effectively loans you a sizable portion of the cash required to buy assets. For example, in a stock margin account let’s say you had been granted the maximum 4:1 leverage, this means that every dollar on your account can purchase $4 worth of the stock.

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