Leverage in forex is a tool that allows investors to increase their purchasing power to invest in derivative financial products. By using leverage, an investor can open larger positions in the market with a smaller amount of capital. This means that an investor can control a trade worth more than the capital they own.
Benefits and Risks of Leverage
Leverage can increase the potential returns of an investment. However, it carries significant risks as it can amplify losses in the same way it amplifies profits. For example, if a trader has leverage of 1:100, this means they can open a trade worth $100 using only $1 of their own capital. While leverage can lead to significant gains, it can also lead to significant losses if the market moves against the trader’s expectations.
How Leverage Works
Leverage works by allowing you to open larger positions than you could with your own funds. Leverage is expressed as a ratio, and it’s important to remember that it will multiply your profits and losses. For example, if you open a trade worth $1,000 using leverage of 1:30, this means you are trading with $30,000. For each point gained or lost in the trade, the profit or loss will be $3. If the trade goes negative by 100 points, you will lose $300, which represents 30% of your initial investment.
The Relationship Between Leverage and Margin
Margin is the minimum required to open a trade, which you must deposit with your broker. For example, if your broker requires a 10% margin to open a $1,000 trade, this means you need to deposit $100. In the case of the forex market, if a trader wants to open a micro lot position with leverage of 1:30, the required margin is 3.33%, which equals approximately $33.
Duration of Keeping Leverage Trades Open
Leverage trades can be kept open until the margin requirement is reached. There may be fees for trades that remain open overnight, known as rollover fees. Rollover fees depend on several factors, including the size of the trade and the type of financial instrument. Generally, the larger the trade and the longer it remains open, the higher the fees.
Benefits of Leverage Trading
Leverage trading can be a powerful tool for traders of all levels. It can help traders open larger positions than they could with their own funds, potentially leading to greater profits. However, leverage must be used wisely, and risks must be managed effectively to avoid significant losses.
Risks of Leverage Trading
The main risk of using leverage is that the trader may lose more than they invested. For example, if a trader invests $1,000 with leverage of 1:100, a 5% decrease in the value of a forex pair would result in a loss of $5,000. In this case, the trader would need to pay an additional $4,000 to the broker. Fortunately, in Europe, Australia, and the UK, traders have negative balance protection, meaning the broker covers losses if the account value exceeds the investment.
Trading Without Leverage
You can trade without leverage if you have enough capital to cover 100% of the trade’s value. For example, if the required margin to open a $1,000 trade is $100, you should have $1,000 in your account. The required margin varies from broker to broker but is generally higher for highly volatile financial instruments like forex.
Changing the Leverage Used
Brokers can change the maximum leverage limit, but this depends on the regulations they are subject to. In some regions like the European Union, Australia, and the UK, the maximum leverage for retail clients is regulated. In these regions, brokers are not allowed to offer leverage higher than 1:30. However, in some other regions, there are no restrictions on the maximum leverage.
Is Leverage Permissible in Islam?
Leverage is permissible in Islam if it is used correctly and legally without any sharia-compliant prohibitions. The broker should not charge any interest on the loan but only a commission for the services provided, such as executing trades, providing information, and technical support.
Frequently Asked Questions About Leverage
What is leverage in forex? Leverage in forex is a tool that allows traders to open larger positions than they could with their own funds.
When is leverage permissible in Islam? Leverage is permissible in Islam if the broker does not charge any interest or rollover fees on trades, as that would be considered riba (usury).
What are the risks of leverage? The main risk of using leverage is that the trader may lose more than they invested. Leverage allows you to open much larger positions than you can afford with your own funds, significantly amplifying your trading results, whether in terms of profits or losses.
Using leverage requires knowledge and prudent risk management to ensure a safe and effective trading experience.
