At the most basic level, on the Foreign exchange market you purchase one currency using another. Effectively you exchang one country’s currency for another’s just like you can at the little booth at the airport when you visit a new country. This requires that currencies trade in pairs, with the most common one being a Euros to US Dollar pair.

With the internet, Forex trading has become more accessible to small time private traders, and if you know how to trade Forex, it’s possible to make a good or even spectacular living trading currency pairs. However, it is also possible to lose a lot of money  as well, so a good grasp on the principles of trading on the Forex market is essential for any novice trader. Even the case if you are thinking of using an automated tool like Forex Autopilot or Forex Killer, as you will still need to understand it to make sure nothing is going sideways.

So what is leverage in Forex trading?

Leverage simply means that you can make a trade without putting up the full amount for the position. A common example of leverage is when you buy a house by only putting down 20% of the value. This increases the risk of an investment, but also allows a forex trader to make more money than would be possible in other financial markets with the same amount of upfront cash.

Forex potentially allows a great deal more leverage than stock trading: up to around 200 times the size of the trader’s account. The amount of leverage does depend on the brokerage company though, although in nearly all cases the amount available is much greater than on the stock market.

Leverage was introduced into Forex to allow smaller players a way into Forex trading.

Because Forex trades typically required larger sums of money, small traders would be completely unable to access the money needed if the market didn’t allow them to trade more money than they have in the account using leverage. When leveraging with a brokerage account, the broker usually has a “safety” system in place to avoid major losses – a type of hold-back amount that is maintained in your account. If the value of the active trades look like they are falling by more than this safety allows, the trader may be asked to either deposit more money or forced to exit the position.

More leverage ALWAYS means more risk!

Properly monitoring your account’s overall risk is vital for success, especially when using a large amount of leverage. The amount of leverage you can use safely will ultimately come down to a mixture of how much your broker allows and how much your trading skill level can justify. There is no doubt that leverage is both the best and scariest weapon in a Forex trader’s armory.  It is how well you use it that will determine which it is for you.

Here’s a bit of good, down to earth advise about leverage from an experienced trader talking to a novice:

…fund a micro account with $1000 and work out your forex strategy with 1:1 or 3:1 leverage. Never risking more than 2-3% of your capital.

The amount of leverage accessible when trading on the Forex market is just one of the reasons why it is so attractive for all traders. It means that with a relatively small investment, a smart trader can identify a potentially lucrative trend and make a lot of money buy ramping up the return using leverage to control a larger amount of the position.

Always be wary of using leverage without a great money management strategy in place to prevent catastrophic losses. A clear understanding of the maximum loss is needed before entering any position, especially when leverage is being used.