Leverage is a mechanism that allows traders to control a larger position with a smaller amount of capital by borrowing from their broker. It is expressed as a ratio such as 1:50 or 1:100, meaning a trader can control $50 or $100 worth of assets for every $1 of their own capital. Leverage amplifies both profits and losses.
When you use 1:100 leverage, you deposit $1,000 as margin and can open a position worth $100,000. The broker effectively lends you the difference. If your $100,000 position gains 1%, you make $1,000, which is a 100% return on your $1,000 margin. However, if the position loses 1%, you lose $1,000 (your entire margin). Higher leverage means smaller price movements can trigger larger percentage gains or losses on your deposited capital. Brokers set leverage limits based on regulations and asset class.
With $5,000 and 1:50 leverage, you can control a $250,000 position. If EUR/USD moves 50 pips in your favor at $10 per pip (standard lot), you gain $500, which is a 10% return on your $5,000. But if it moves 50 pips against you, you lose $500 (10% of your capital). With 1:500 leverage on the same $5,000, you could control $2,500,000, but a 20-pip move against you would cost $5,000, wiping out your entire account.
Leverage is often called a double-edged sword because it magnifies gains and losses equally. While it allows traders to access markets with less capital, excessive leverage is the primary reason most retail traders blow their accounts. Understanding leverage is critical for proper risk management. Professional traders typically use much less leverage than the maximum available, often controlling risk through position sizing rather than high leverage.