Leverage is the ratio between the amount of money you deposited and the amount of money you can trade. Additional money (leverage) is provided by your broker.
Leverage increases your trading power allowing you open positions larger than you could open having only your private funds. The ratio can be reflected in “X:1” format.
Let’s see how it works on the example.
Imagine you traded the USD/CAD pair on January 5th, 2018. That day the Canadian unemployment rate fell, and USD fell to CAD from 1.2500 to 1.2360. You opened a position with 1000 euros. As a result, you could earn around 11 euros.
Now we will consider 1:30 leverage option. Let’s suppose that you don’t have 1000 euros. You invest 100 euros and use 1:30 leverage. As a result, you have 3000 euros. Trading same currency pair on the same day, you could have a profit of 34 euros. You invested less and earned more.
However, we want to warn about the risks of leverage.
If you trade without leverage, earning 11 euros, your return will be 1,1% (11 euros /1,000 euros *100). At the same time, losing 11 euros, your loss will be -1,1% return as well.
With the leverage your profit increases, however, loss rises, too. In the case of 34 euros profit, your return will be 34% (34 euros /100 euros *100). If you lose $34, the return will be -34%. As you can see, with leverage small movements of the currency pairs can result in larger profits or larger losses when compared to an unleveraged position.