You may say to yourself “I don’t have enough money to trade FOREX”.
Seeing that by investing 10,000 Euro to trade EUR/USD you would earn 1 USD per pip you could say, I do not have 10,000 Euro.
Guess what, you can trade 10,000 worth of Euro by investing less than 20 Euro of your own money, through the use of Leverage.
Leverage multiplies your investment amount by a given multiple and allows you to trade a multiple of your deposited investment amount.
When you open an account with a FOREX broker you get a choice to select leverage. You can see leverage offered from 1 to as high 1000.
You selected a leverage of 500 (sometimes presented as 500:1) and you make a deposit of 200 Euro. This allows you make trades worth up to 100,000 Euro ( 200 x 500 =100,000 Euro)
You selected a leverage of 100 (sometimes presented as 100:1) and you make a deposit of 500 Euro. This allows you make trades worth up to 50,000 Euro ( 100 x 500 =50,000 Euro)
Hence leverage allows you to make much bigger profit returns with a smaller investment amount.
Trading on Margin/How does this work:
Leverage can be also thought as a form of loan between you and the broker. The broker allows you to trade bigger amounts of your deposited amount, provided you maintain a certain amount in your account. The amount required to be maintained in your account is called Margin.
You will see a lot of times the brokers use the terms Required Margin per Lot. This is the amount required for your account to have in order to open 1 Lot of that Currency pair.
Most of the trading performed in online FOREX trading is through Contracts For Difference (CFD). This is because you make a trade, without actually acquiring ownership of the instrument traded, and when you complete the trade (exit) you receive the difference between the entry and the exit price, or pay the difference if you are in loss. Note that under CFD trading the brokers may set the trading conditions, spreads, quotes different from the rest of the market and charges, as they wish as they create a trading product between you and them.