Most online foreign exchange transactions are conducted through margin. Whether it is leveraged trading, leverage effect, leverage ratio, magnification, etc., they all refer to the same thing. Investors only need to invest a portion of the margin to establish and maintain a complete contract with a larger total contract value through "leverage".
Calculating leverage is not difficult and can be explained using a few formulas:
Margin requirement = total contract value (position) / magnification (leverage)
Leverage ratio = Margin requirement / Total contract value (position)
Leverage = 1 / Leverage Ratio
For example, if broker A offers a leverage of 100:1, it actually means that the transaction can be magnified 100 times. If an investor chooses to buy one standard contract of USD /JPY, that is, a contract of 100,000 USD, the investor only needs to use (100,000 USD/100 times) = 1,000 USD as margin to establish this position, and 1,000 USD/100,000 USD = 1%, and 1% is the leverage ratio.
For example, if a trader expresses leverage at 1%, then in reality the magnification factor can be calculated as 1 / 1% = 100.
It should be noted that some traders can choose to fix the amount of margin requirements, but the formula will never change, resulting in the actual magnification factor to change with the total contract value in response to market changes. Generally speaking, most traders will fix the leverage, so when the total contract value changes in response to market changes, the margin requirements will change accordingly.
Leveraged trading is common in the financial market and can increase the size of investors' trading by dozens or even hundreds of times. However, at the same time, there may be misunderstandings among the public, especially among novice investors, that leverage is inevitably related to risk. Leverage allows investors to establish larger positions with less capital, but the size of the risk is based on the total value of the contract held, not the leverage itself.
If an investor holds a contract of the same size, such as $10,000, and unfortunately the price drops by 2%, the loss is $200. Even with or without leverage, 10 or 20 times leverage, the loss is still 2% of the relevant price change of the contract, or $200.
However, some sudden and drastic fluctuations may also cause investors to be forced to close their positions due to insufficient margin. This is also an additional operational risk. However, as long as leverage is used appropriately, position size is limited and more margin is deposited, the corresponding risks can be controlled.
Therefore, the market generally describes leverage as a double-edged sword, meaning that it may bring greater gains but may also result in greater losses.
All financial products traded on margin carry a high degree of risk to your capital. They are not suited to all investors and you can lose more than your initial deposit. Please ensure that you fully understand the risks involved, and seek independent advice if necessary.