Understanding the Benefits of Forex Leverage
Leverage as a general term is a noun meaning the action of a lever or using a tool to accomplish some work. In finance and the Foreign Exchange trading business, its meaning is a little bit more complex yet is aiming for the same motion. Forex leverage is the use of different means or financial instruments such as borrowing funds or buying by margin used by many investors to cover potential losses or to increase the potential rate of return of their investment.
Leverage is a powerful tool for any investor to gain great amount of profit and yet considered risky and dangerous at times because this is a way of financing a company’s assets through a great amount of debt with or without actually having their own funds. The brighter side of doing this action is actually increasing or maximizing the utilization of the traders investment power for as long as they have that efficient money and eventually increasing return of the investment. However, there is great danger in doing this, so efficient, wise and specific risk management plans is very much essentials.
Most experts will advise you, if you are planning and looking to have considerably high leverage for your business, that there are some things you should first know in order to avoid or be prepared for the risks. You should be aware of the rules and limitations of this process and how to handle it. Also, it is better to fully understand the pros and cons of the activity for your firm’s sake and for other parties. If you know how to play the game you can be highly profitable.
In order to understand Forex Leverage more, take this example; To trade a 100,000 units of AUD/USD, in the traditional way you will need the same amount which is 100,000 USD of actually owned money, meaning 1:1 leverage. So, when we say 100:1 leverage, the investor or traders are only required to give or deposit 1/100 of the settled amount, wherein in this case it is equivalent to 1,000 US dollars. In other words, for the given example, whenever a trader have or willing to invest 1,000 US dollars he or she can control 100,000 USD position which is actually the market value of one standard lot.
Most of the time a company’s capability to meet its financial obligations or its stability to be attractive in the market is measured by its leverage ratio or financial ratio; this is why it is important to understand. The bigger the company’s leverage, the bigger its assets and stable means but it also indicates higher possibility of difficulties in paying the debts equivalent interest and principal as for the traders himself. There are several other ratios, but for leverage ratio or most commonly stated as debt to equity ratio, the main factors included are equity, assets, debts and interest expenses.