Leverage works by using a deposit, known as margin, to provide you with increased exposure to an underlying asset. Essentially, you’re putting down a fraction of the full value of your trade, and your provider is loaning you the rest.
Your total exposure compared to your margin is known as the leverage ratio.
For example, let’s say you want to buy one lot of GBP/USD at 1.2860.
One lot of GBP/USD is equivalent to $100,000, so buying the underlying currency unleveraged would require a $128,600 outlay (ignoring any commission or other charges). If GBP/USD goes up by 20 pips to 1.2880, your position is now worth $128,800. If you close your position, then you’d have made a $200 profit (less than +1% return relative to what you paid).
UNLEVERAGED
If the market had gone the other way and GBP/USD had fallen by 20 pips, you would have lost $200 (less than -1% return relative to what you paid). Or you could have opened your trade with a leveraged provider, who might have a margin requirement of 10% on GBP/USD. Here, you’d only have to pay 10% of your $100,000 exposure to open the position. If GBP/USD rose 20 pips, you would still make the same profit of $200, but at a considerably reduced cost. Of course, if GBP/USD fell 20 pips then you would still lose $200, too – a larger loss in comparison to your initial deposit.
LEVERAGED
