Have you read the article I wrote on Pips and Lots?

Now, in that article I mentioned that currency is traded in Lots. We also know that each standard lot size is worth USD100,000. There are brokers who provide smaller lots to trade at $10,000.

But still, the money involved, or more accurately the capital required to start trading is enormous, yes?

NO.

Let’s learn a new term today. Leverage!

Leverage by definition is

"The use of a small amount of cash to control a large amount of commodity, in this case : currency".

Simply put, your FOREX broker will lend you a large amount of money to trade provided you have a specified minimum amount of balance in your trading account.

For example if your broker gives you a 100:1 leverage, you can control a lot the size of $100,000 for every $1,000 you have. If you have $3,000 you can trade $300,00 dollars!!!

Why is Leverage important?

Remember Pip Value? Surely you have noticed that the increment size of any currency is as small as 0.0001. So, for you to receive any significant profit, you have to trade with large amount.

For example,

Your broker allows you a leverage of 100:1 which means you can trade a $100,000 sized lot with $1,000

You predicted that GBP rate will rise against US Dollars. So, you opened a lot, buy buying GBP at 1.9869.

After a while, your prediction comes true. The GBP rises against USD. So you close your position at 1.9919.

You earn 50 pips. Convert to dollar amount, you get $500

Your initial capital was $1,000 right? So you make a cool 50% profit!!!

You will not earn that much without leverage.

But,

Always remember that Leverage is a two edge sword.

Just imagine you prediction go wrong and you are down by 50 pips instead. That will give you a 50% loss!!!

So, always trade cautiously. And use leverage wisely.