Definition Of Forex Leverage

Forex leverage is the multiplicative power that is being offered by forex investment programs when trading your account. Forex leverage allows a forex investor to control a large amount of money with just a fraction of that amount in their capital.

The Real Estate Analogy

Let us make an analogy for you to better understand the power of forex leverage which can be extremely profitable if an investor can just harness its full potential. Let us compare the power of forex leverage to the advantage of owning a house thru a mortgage.

Very few people purchase their own homes via cash. Most of the time, the normal course of owning a house requires a mortgage. A person puts up a certain percentage of the house’s value as his downpayment for the house. Then, the rest of the amount is paid thru a loan with the house itself serving as collateral.

The house, officially, is not yet his until he is able to fully-pay the mortgage amount. But for all intents and purposes, he has control on how he wants to improve, decorate and use his house. He is already considered as the homeowner of that house.

Thus, should he decide to rent it out to other people for extra income, he can do it. Should he decide to sell the house later on when the price of real estate in the area goes up, he can also do so and earn himself a pretty handsome profit. As long as at the end of the term, he pays up the mortgage, then he can do whatever a rightful owner can do with his property.

The same is true for forex leverage. When an investor invests thru a broker in the forex market, he actually arms himself with a ready “mortgage” that he can use for every trade that he does. In this case, the “mortgage” is the forex leverage. For every trade that an investor makes in forex, his broker only requires him to put up 1/100 of the amount of the contract. For example, a forex investor wants to buy $100 amount of Euros using the current exchange rate in the forex spot market. He does not have to use the whole $100 in his portfolio to purchase the Euros. He just needs to put up $1 for the trade transaction. The rest of the $99 balance is like a mortgage that he would pay up when he finally decides to sell the Euro in exchange for US dollars once again.

As long as he does not decide to exchange the Euros that he bought with his $1 (own) + $99 (forex leverage) back to US dollars, he has total control over the Euros that he bought. Interest income that he gains just by possessing those Euros over US dollars are all his. It’s just like renting out the house that you mortgaged to earn extra income. Forex leverage allows you to earn extra interest income over money that you only borrowed.

And when the time comes that the Euro’s value appreciates to an acceptable level for him, let’s say 5%, he sells the Euros that he back in exchange for US dollars once again. And when he does that, he pays back the “mortgage” that he borrowed and keeps the rest of the money as his. The profit that he gains from the forex leverage is all his. So, even is he only puts up $1 of his own money to invest in the trade, and the value of the Euro goes up by 5%, he does not only gain 5% of $1, but 5% of the whole $100 – all because of forex leverage. That is a $5 profit for his $1 investment. Forex leverage allowed him to achieve a return from his investment of a staggering 500%.

That is how forex leverage can be utilized to multiply the value of your investment. That is how forex leverage can help you earn lucrative returns for your investment.

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