How Forex Leverage Works
Investing in the foreign exchange market, or rather the Forex market, is a great way of expanding business and the possibility of getting better returns. In Forex trading, leverage can be a double-edged sword, while it can significantly increase an investor's gain potential, leverage can also increase your loss potential.
In the world of finance and commerce, the 'word' leverage implies a technique to increase or multiply the returns on investment for a particular investment or set of investments. In some cases it also implies the increasing of equity or net worth of a business. Though the term is broad and covers several different assets, business and investments, a Forex leverage is basically a method or a set of methods, which are used to increase the net worth or realizable value of an asset or the returns of a certain investment. Leverage is conventionally achieved with the help of borrowings, contracts or debts. In case of Forex leverage, the credit or loan for the process is provided by the Forex brokers.
It must be noted that the theory, facts and mechanism of Forex leverage tends to sound surrealistic and almost like a bluff, however, that is the way it works.
What is Leverage
To understand how Forex leverage works, one needs to understand how Forex trading works and the meaning of PIP and BP. Here's a quick reminding illustration of the same.
When you invest money in market such as a money market, stock market or in this case, the Forex market, there are three kinds of benefits or profits which you can reap, if the investment is done thoughtfully, logically and in a well analyzed, reasoned and calculated manner. The first one is the sale value profit, which is basically obtained from selling the owned investments at very high price from the price at which it was purchased. The second type of benefit is the period return that you receive from the investment such as dividends on shares/stock. The last one is broadest and is commonly known as total return on investment. This is the total and overall gain you have made from the investment. This amount is the cash or non-cash and may be realizable or unrealizable. With the help of Forex leverage, what we do is, increase the total amount that you hold in the Forex market in some other currency. There are two prominent ways with the help of which this can be done.
The first step is to open a marginal account with the broker when you are dealing in Forex. Then you can borrow, some money from the broker to invest in some other 'quote currency'. There is of course, a minimum amount you have to personally put in, before which the broker does not sanction the loan. The loan sanctioned is usually expressed in a ratio such as 5:3 or in percentages such as the 60%. The latter number or the percentage is the amount which is invested by you into the marginal account. It is basically your own investment. In this case, the broker will be loaning you 40% of the total investment. The 40% loan is your leverage.
Now the second method with the help of which you can opt for Forex leverage is by using derivatives. Derivatives are contracts wherein you as an investor has the right, but not the obligation, to purchase a currency at a predetermined price. Now this type of contract considerably increases the value of asset which you are holding whereas you actually invest or quote less. Note that a careful study is required to exercise the right properly.
Read more at Buzzle: http://www.buzzle.com/articles/how-forex-leverage-works.html
Investing in the foreign exchange market, or rather the Forex market, is a great way of expanding business and the possibility of getting better returns. In Forex trading, leverage can be a double-edged sword, while it can significantly increase an investor's gain potential, leverage can also increase your loss potential.
In the world of finance and commerce, the 'word' leverage implies a technique to increase or multiply the returns on investment for a particular investment or set of investments. In some cases it also implies the increasing of equity or net worth of a business. Though the term is broad and covers several different assets, business and investments, a Forex leverage is basically a method or a set of methods, which are used to increase the net worth or realizable value of an asset or the returns of a certain investment. Leverage is conventionally achieved with the help of borrowings, contracts or debts. In case of Forex leverage, the credit or loan for the process is provided by the Forex brokers.
It must be noted that the theory, facts and mechanism of Forex leverage tends to sound surrealistic and almost like a bluff, however, that is the way it works.
What is Leverage
To understand how Forex leverage works, one needs to understand how Forex trading works and the meaning of PIP and BP. Here's a quick reminding illustration of the same.
When you invest money in market such as a money market, stock market or in this case, the Forex market, there are three kinds of benefits or profits which you can reap, if the investment is done thoughtfully, logically and in a well analyzed, reasoned and calculated manner. The first one is the sale value profit, which is basically obtained from selling the owned investments at very high price from the price at which it was purchased. The second type of benefit is the period return that you receive from the investment such as dividends on shares/stock. The last one is broadest and is commonly known as total return on investment. This is the total and overall gain you have made from the investment. This amount is the cash or non-cash and may be realizable or unrealizable. With the help of Forex leverage, what we do is, increase the total amount that you hold in the Forex market in some other currency. There are two prominent ways with the help of which this can be done.
The first step is to open a marginal account with the broker when you are dealing in Forex. Then you can borrow, some money from the broker to invest in some other 'quote currency'. There is of course, a minimum amount you have to personally put in, before which the broker does not sanction the loan. The loan sanctioned is usually expressed in a ratio such as 5:3 or in percentages such as the 60%. The latter number or the percentage is the amount which is invested by you into the marginal account. It is basically your own investment. In this case, the broker will be loaning you 40% of the total investment. The 40% loan is your leverage.
Now the second method with the help of which you can opt for Forex leverage is by using derivatives. Derivatives are contracts wherein you as an investor has the right, but not the obligation, to purchase a currency at a predetermined price. Now this type of contract considerably increases the value of asset which you are holding whereas you actually invest or quote less. Note that a careful study is required to exercise the right properly.
Read more at Buzzle: http://www.buzzle.com/articles/how-forex-leverage-works.html
