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Subscribe Stay on top of Forex market updates, Everyday. Subscribe to our Daily Market Insights! The concept of leverage is really quite simple, but its true meaning often becomes lost in the mountain of marketing-speak most forex brokers dish out at us traders. Margin – The amount of collateral a customer deposits with a broker when borrowing from the broker to buy securities. This is your account balance when you first open your account. The use of credit or borrowed funds to increase one’s speculative capacity and increase the rate of return from an investment, as in buying securities on margin, although it can also increase the rate of loss by the same factor. Your leverage depends on the size of the trades you make relative to your account equity, and nothing else, as long as you don’t surpass the maximum leverage the broker allows.
This definition applies to trading accounts. The more general definition of financial leverage is somewhat more complicated, but luckily it is unnecessary for our current purposes. As I stated before, this number generally does not vary unless you specifically change the deal with your broker. To recap then, the major difference is that the margin requirement is set by your broker, which determines your maximum leverage. How much of that available leverage you use in your trades is entirely your choice. Your broker does not set your leverage.
They just set the maximum that you can use. Please note that the equation uses forex notation, and not true mathematical notation. If you would like to use mathematical notation, currency pairs should be inverted. If that looks complicated, please don’t worry, it isn’t.
These calculations ignore the spread, which would affect P. Equations for that become more complicated because we have to include the pip value. In this example, it would be simple, but for pairs where the quote currency is not the same as the account currency, our leverage equation would be significantly more complex. Please note also that this formula works equally well for pairs which do not involve the account currency, but we have to be careful to make the right substitution, and we need a bit of extra information.