Learning how to calculate leverage is crucial in forex trading. The forex market is the largest financial market with a daily traded volume of about $7 trillion. It allows traders to open relatively large positions with very little capital, using Leverage.
This is why the Forex market has many participants compared to other financial markets.
But despite the huge winning potential leverage has to offer, it is commonly described as a double-edged sword. The reason for this is going to be discussed in this article. We will also discuss how to calculate leverage, the risks involved in trading leveraged currencies, and other related concepts.
Leverage in Forex Simplified
What is leverage in forex? Leverage is simply a trading amount offered by Forex brokers which allows traders to open larger positions using a little trading capital as collateral. The leverage provided by Forex brokers is a lot bigger than that of the stock, bond, and other financial markets, adding to the reasons why beginners are so attracted to the Foreign exchange market.
A liquid currency pair in forex is one that remains stable in price when it is bought or sold. That is buying or selling such currency pair has very little effect on its price.
The huge leverage offered by forex brokers is owed to the fact that the forex market is more liquid than its market counterparts. This is because the normal daily changes that occur can be as little as 0.01 pips. So, the forex market is much more stable, and the risk associated with using leverage is a lot less than that of the stock market.
Also, leverage trading is not borrowing as many would like to define. Let us assume for a moment that you are trading with a leverage of 500:1 with a deposit margin of $100. Now, your position will be magnified to $50,000, but this does not mean that the whole $50,000 is yours. Neither does it mean you borrowed an additional $49,900.
The 100 dollars used to enter this leveraged trade is nothing but an act of goodwill, and by entering this type of trade, you are only at risk of losing $100 and not $50,000. The only difference between this and normal forex trading is that both your potential wins and losses will be magnified. So do not worry about how they cover up for the supposed borrowed money.
For more information on how Forex brokers make their money, you should scan through the content table in Forex Trading Simplified.
How Do I Know My Leverage?
To know your leverage in Forex, you can go through your trading account before entering any position. Since it is signified by some Forex brokers. But if it isn’t, some brokers may decide to display it using margin. There is a simplified way to calculate leverage using the margin variable provided to you which we will explain below.
Margin is the lowest amount you need to have as deposit to enter a leveraged trade.
How To Calculate Leverage In Forex
Knowing how to calculate leverage in Forex is very important for beginners. This is because it gives information like the trade size, and deposit margin required for this trade… It also tells a Forex trader how to manage risk accordingly.
Leverage by technical definition is the ratio between the trade size or contract size and the deposit margin. It is calculated thus:
How to Calculate Leverage using Contract Size and Deposit Margin
Leverage = (contract size) / (deposit margin)
The contract size is the actual amount of the currency you control when trading with leverage.
EXAMPLE
You intend to enter a trade with a contract size of 60,000 units of a currency (e.g $60,000), assuming your Forex broker would only accept a thousand-unit marginal deposit (e.g $1000), your leverage will be:
Leverage = 60,000 ÷ 1,000 = 60
Which expressed in ratio would become a 60:1 leverage.
This means you entered a $60,000 trade with $1000 thanks to leverage.
How to Calculate Leverage Using Margin Percentage
The margin percentage is margin expressesd as a percentage of your contract size.
Another way to calculate leverage in forex is in terms of margin or margin percentage. This method is expressed thus:
Margin = contract size × margin percentage
For example with a margin percentage of 2% and a contract size of 100,000 units of EUR/USD. The margin can be calculated as:
Margin = 100,000 × (2/100) = 2000
Now we can calculate leverage from the margin percentage.
Leverage = contract size/margin.
Since margin = contract size × margin percentage
Leverage = contract size / (contract size × margin percentage)
Leverage = 1/(margin percentage)
This, in a simplified form, means that with a margin of 0.02 or a margin percentage of 2%
Leverage = 1/(2/100) = 100/2 = 50
Which is a 50:1 leverage.
This is how to calculate leverage using margin percentage.
Forex Terms That Relate To Leverage
Below are three Forex terms that are related to leverage.
- Margin
- Pip
- Equity
Margin
Margin is simply the amount of trading capital that is to be deposited in good faith (or as collateral) before a Forex broker will allow you to enter or maintain a leveraged position. It is normally expressed as a percentage of the full trade position or the Notional value. Margin is calculated using the formula:
Margin = (lot size × contract size) / (leverage)
Where lot size could be standard, micro, or mini-sized. One standard lot size for example equals 100,000 units of the base currency. Therefore, two standard lots will be (2×100,000) units.
Contract size in inclusion, is the amount of currency within a lot. It varies depending on the currency pair. For example, a standard-sized lot for the EUR/USD equals 100,000 euros, but a standard-sized lot for the USD/JPY pair equals 100,000 dollars. These are the contract sizes for these lots.
EXAMPLE
If you’re trading one standard lot (which is 100,000 units) of EUR/USD with a 20:1 leverage ratio, then your margin requirement is:
Margin = (1 × 100,000) / 20 = $5,000
In addition to this, there is something called a margin call in forex trading. A Margin Call in simplified terms is a situation whereby a Forex trader is notified that his margin deposit can no longer match up with the equity required to maintain that position. In this case, the Forex broker provides three options:
- They automatically close this position at the present price to protect your trading account balance,
- You close it yourself,
- Or you deposit more money to maintain your position.
Pip Value
A pip simply means Point in Percentage. It is used to represent the fraction change in the prices of currency pairs and it tells a forex trader the amount gained or lost in the quoted currency when trading with leverage. Pips can be calculated for a particular currency pair using this simplified formula.
Pip Value = (lot size × tick size)/exchange rate
Tick size for most major currency pairs = 0.0001
But for a more volatile Japanese Yen,
Tick size = 0.01
EXAMPLE
You bought one standard lot of EUR/USD, where the tick size is 0.0001, and the exchange rate is 1.3500, the pip value would be:
Pip Value = (1 × 0.0001)/1.3500 = 0.0000741 dollars
This means that every pip movement is worth $0.0000741.
Equity
Equity in forex can be defined as the trading balance plus or minus (±) profits or losses from currently active trades. It tells a trader the total amount of money he has when actively trading (with open positions). Equity can be expressed mathematically as:
Equity = current trading balance + profits in active trades – losses on active trades
When a Forex trader leaves an open trade, his equity becomes his trading account balance. Also, when an equity goes below the required margin, the trader receives a margin call.
Understanding how to calculate leverage in forex alongside these concepts gives you a hedge in making informed decisions and it also helps to properly manage risks.
How Much Is The 500:1 Leverage?
As a beginning Forex trader, we thought it wise to expose you to specifics like this. You are going to encounter similar topics as you read on. How much is the 500:1 leverage? The simplified answer is very much.
Here is a more detailed answer. A 500:1 leverage means that with just $100, you can control a $50,000 position. Or with $1,000 you can buy as large as $500,000 worth of currency. So you can see what we mean by very much. Note that it is very unlikely to find a forex broker that will offer you this leverage as a beginner.
What Is A 200 To 1 Leverage?
This leverage, on the other hand, is relatively lesser than the other leverage, and therefore less riskier and more applicable. The same concept used for the leverage above will also be applied here.
To get the trade size for a 200 to 1 leverage you just multiply the margin deposit by 200. For example, with a $200 margin deposit, you should be able to enter a $(200×200) or a 40,000 dollar position.
How To Manage Risks With Leverage
Understanding how to manage risks when leverage trading is very vital for a beginning forex trader. As explained previously, leverage is a double-edged sword. The larger the leverage, the higher your potential wins as well as your potential losses. Below is a diagrammatical description of this.
| Leverage Ratio | % change in Trade size | Equivalent % change on margin deposit |
| 100:1 | 1% | 100% |
| 50:1 | 1% | 50% |
| 30:1 | 2% | 60% |
| 10:1 | 4% | 40% |
| 10:1 | 1% | 10% |
| 20:1 | 1% | 20% |
From the table above, we see that while using a 100:1 leverage ratio, a 1% change (profit or loss) in the leveraged trade will equal a 100% change in the margin deposit.
Further below are some leverage recommendations to help beginning forex traders with small trading accounts to manage risks.
What Leverage Is Good for A $200 Account?
The best leverage for a $200 account is described by leverage.trading according to risk tolerance. For a 200-dollar account:
- Low Risk = 8:1 leverage
- Medium Risk = 10:1 leverage
- High Risk = 25:1 leverage
What Leverage Is Good For A $5 Account?
Now, a $5 account is a very small trading account, but there are still beginners who have used it as a starting point. Some of them even go on to excel in the Forex market. Here are our recommendations for a $5 account:
- Low Risk = 15:1 leverage
- Medium Risk = 30:1 leverage
- High Risk = 50:1 leverage
DISCLAIMER
Managing risks constituted by leverage is not a 100%-win guarantee. A successful leverage trade works hand in hand with the skill level of the Forex trader.
This is our way of saying that we are not to be blamed for any losses incurred while trading with leverage as this is merely just our opinion.
1:100 Leverage Vs 1:500 Leverage
As a beginner, you may come across inverted notions like these. Now, one may ask–given the diverse definitions stated above–does this mean I’ll have to stake $100 or $500 for an equivalent $1 position? No, it doesn’t mean any of that. Some brokers just choose to turn it the other way around.
A 100:1(or 1:100) leverage has 5 times less buying power than a 500:1(or 1:500) leverage. This means that with $1, a trader can enter a $500 position for a 1:500 leverage or a $100 position for a 1:100 leverage.
Frequently Asked Questions About How to Calculate Leverage
Can I Trade Forex Without Leverage?
Yes, you can trade forex without leverage. Leverage is just there to give traders with limited capital a hedge to compete with the big players.
How Much Is 1:50 Leverage in Forex?
A 1:50 leverage is the same as a 2% margin. It means that with a $1 margin deposit, you can enter a $50 trading position. Or with a $1000 margin, you can control a $50,000 position.
Which Leverage Is Best for Small Accounts?
It depends on your Forex skill level. But overall, and due to the high potential of blowing your account, the recommended leverage for small accounts is around a 1:10 ratio.
Which Leverage Is Best for Beginners?
Beginning Forex traders are better off using a leverage trade ranging from 1:2 to 1:10. This is simply because they do not have the adequate skill level to manage higher leverages.
How Are Pips Calculated in Forex?
Pips can be calculated using the tick size and exchange rate formula. It is stated thus:
(change in currency pair price) ÷ (tick size).
Where tick size is 0.0001 for most currency pairs and 0.01 for the Japanese yen and the change in currency pair price is the difference between the previous and present exchange rates of the currency pair in question.
A Conclusion on How to Calculate Leverage
Learning forex trading terms like margins, and pips, and how to calculate leverage in forex can help beginners to better understand forex trading. With a better understanding of these variables in forex, a trader will be able to make better Risk Management decisions and build a proper Risk Management Strategy.
References
Liquid – What liquidity is by blueberrymarkets.com
Pips – What pips are by Investopedia
Margin – Margin trading according to Investopedia
Trade size – Definition of trade size by forex.com
Notional value – The notional amount explained by babypips.com
Equity – What equity is by axiory.com
Tick size – Definition by Investopedia
How to manage risks – Steps of risk management in leverage trading
Leverage.trading – Article on leverage trading ratio by Leverage Trading