The concept of leverage in the forex market can be one of the most challenging to understand, especially as it relates to margin. We’ve been approached by several of our clients who are curious to know how 1:1 leverage works when trading forex. Given how often this question comes up in discussions, we’d like to share a detailed answer with our global audience.
1:1 leverage simply means that one is trading forex without any type of leverage. In practical terms this means that if you exchange 1,000 Euro for the equivalent in dollars, you would need to exchange the full amount.
How Does 1:1 Leverage Work In the Forex Market?
To better understand this concept, let’s imagine that you find yourself at the airport currency exchange booth. If you’ve ever exchanged your money at an airport before, then you are essentially trading on 1:1 leverage.
Taking the example further, let’s say that you exchange 500 worth of Euro for dollars during a visit to the United States. Unfortunately, you misplace the money you exchanged, only discovering it in your clothing after returning from your holiday. When you look at the exchange rate of the dollars you purchased, you discover that during your visit the dollar strengthened significantly, so when you exchange your money back at your bank, you receive 580 Euro, netting a small profit.
In this hypothetical example, you made a trade on 1:1 leverage. Most likely you wouldn’t look at it in this way but in essence, you fully exchanged one sum of money for another – that is essentially 1:1 leverage, which in other words means no leverage at all.
The Advantage of Leverage When Trading Forex
The reason that leverage in the forex market exists is due to the fact that the price of currencies do not exhibit major price fluctuations on a daily basis. Generally speaking, the Euro only moves 1 or 2 cents from day to day against the US dollar. For this reason, there is little potential for financial gain when exchanging 100, or even 500 Euro on a short term basis. The only way to realize any true type of financial profit is to trade a larger amount, like 1,000 or 10,000. This is where the concept of leverage enters the picture. Via leverage, investors are able to maximize returns (and also losses) by having more available capital at their disposal.
Let’s consider an example. Imagine trading with a broker that is offering 100:1 leverage. Essentially, 100:1 leverage would allow an investor to trade up to 100,000 units of currency (US dollars, Euro, or British pounds). The beauty of leverage is that the investor in our example would only need to deposit $1,000 of their own money as margin in order to control up to 100,000 of purchasing power! This is why it doesn’t make sense for a broker to offer 1:1 leverage. Imagine for a moment that leverage wasn’t available, if an investor wished to perform the same transaction on 1:1 leverage, they would need to have $100,000.
Forex Consulting – Consultation Services for New and Experienced Traders Alike
If you are new to FX trading and are looking for the right broker to partner with, we are happy to assist you. We are more than happy to refer you to several reliable and trustworthy forex brokers. Get in touch with us today to explore this opportunity further!