Leverage is a financial tool which allows you to have the ability to control a large amount of the position with a very small amount of your capital.
For example, in FXPrimus, it offers different leverages like 50:1, 100:1, 200:1, 300:1, 400:1 and 500:1. What it means then?
If we take leverage 500:1 and we want to long 1 lot(100, 000 units) of EUR/USD, meaning we only need put a deposit of 1/500th of EUR100,000, which is EUR200 to open a new position and not EUR100,000 if no leverage is being used.
In the following example, we’ll examine how leverage is utilized in a Mini Account (10,000 Base Currency Units) using 200:1 (0.5%) leverage. Let’s say the EUR/USD is trading at 1.3000/1.3003. If we long 1 lot (10,000 units) of EUR/USD, meaning we are buying EUR and selling USD, so we are buying 1 Lot (10,000 Units) of the Euro at 1.3003. This will cost us USD13,003 (10,000 X 1.3003.) In order for us to be able to buy this amount, we must have 0.5% of the total cost of the purchase price available in our account. So in this example, we must have 0.5% of USD13,003 which equals USD65.02.
In the Eur/Usd, every 0.0001, is referred to as a pip. In the example above every pip is equal to USD1. If the price of the Eur/Usd were to increase from 1.3003 to 1.3053, that would equate to a 50 pip increase, or USD50 profit. Conversely, if the price were to decrease to 1.2953, that would equate to a 50 pip decrease, or USD50 loss.
An important factor to consider is that the contract sizes are not all the same. What this means is that, for example, in a mini account, 1 Lot of the Eur/Usd currency pair is not equal to 1 Lot of the Usd/Chf. Even though they are both 1 Lot, they have different notional value, thus affecting how much margin is required to establish each position. Please see the following examples below to see the difference:
1 Lot of Eur/Usd in a Mini-Account with 100:1 (1%) Leverage
If you long EUR/USD at a rate of 1.3003, converted to USD, this position would require USD130.03. This is derived by multiplying the amount of Euros bought (10,000) by the exchange rate (1.3003.) You would then multiply this amount (USD13,003) by the margin (1%) and that would produce the required margin amount of USD130.03.
1 Lot of Usd/Chf in a Mini Account with 100:1 (1%) Leverage
Conversely, if you are long the Usd/Chf at the rate of 1.0766, there is no conversion needed since Usd is the base currency. Calculating the margin needed is simply accomplished by multiplying the amount of Usd bought (10,000) by the margin (1%) that would produce the required margin amount of USD100.
LEVERAGE AMPLIFIES POTENTIAL LOSSES OR GAINS. WITHOUT PROPER USE OF RISK MANAGEMENT, THE HIGH DEGREE OF LEVERAGE MAY LEAD TO LARGE LOSSES.