A lot of forex broker sites will offer leveraged forex trade. This means that they are willing to lend you money that you can use for your trading. How much you can borrow will usually depend on how much of your own money you put into the transaction. There are for instance forex brokers that will lend you 100 Euro for each 1 Euro of your own money. So, if you have €100 to invest, the broker will lend you €10,000.
Leveraged buys are not limited to forex brokers. There are a lot of brokers that offers leveraged stock purchases, leveraged options purchases, etc. However, the FX market has become famous for the exceptionally big leverages offered by the online brokers.
The reason why your FX broker is willing to lend you money is found in the business model of the average FX broker. An FX broker will make money on your trades regardless of whether you make a profit or lose money, and the larger your transactions are the more money the broker will earn. This is why it makes sense for FX brokers to lend their clients money.
When you borrow money for your trading, you can end up in a situation where you lose much more money than you deposited into your trading account. This might seem self-evident, but there are quite a few examples of inexperienced traders that fails to realize that the money they borrow must be paid back to the lender. The agreements that you enter into before you commence leveraged trading will typically make your personally responsible for the loan. So, if you lose money on your forex trade, you will be obliged to use your personal assets to pay back the broker that lent you the money.
To mitigate risk, most FX brokers have safety measures in place which will automatically close your positions when the decrease in value reaches a certain point. This might feel as added security for you, but it also puts you in a situation where your loss will be realized even if it is just a very short dip in value. If you had been allowed to make your own decisions, you might have decided to just hang tight instead and wait for the value to go up again, rather than making an emergency sale. Before you decide if you want to use leverage (i.e. borrow money from your broker for your trading) you should investigate exactly where these stop-loss spots are and make an informed decision. That way, you don’t have to be surprised by seeing your positions close automatically when something, e.g. a terror attack, has caused a sudden serious – but probably short lived – dip in the value of a currency.
For some traders, leverage is a great tool that helps them make a substantial profit despite not having a lot of initial capital to deposit. For others, the easy access to borrowed money has a detrimental impact on their psyche and causes them to take much larger risks than they would if every penny risked came from their own hard-earned paycheck. Before you decide to borrow money from your FX broker, try to be as blunt and honest with yourself as possible. How is your track record when it comes to risk management? What can you see when you look at previous situations where you have had to handle risks? Is there a difference between how you handle financial risks as opposed to other risks? What does your financial situation look like, and how would you handle a situation where you are forced to use personal non-FX assets to pay back the loan?
Last but not least, it doesn’t have to be black or white. You don’t have to chose between zero leverage and maximal leverage. Just because your FX broker is offering you a 1:100 leverage it doesn’t mean that you have to borrow €100 for each €1 just because you decide to use leverage. Maybe a smaller leverage is the right choice for you? Even if you just accept a €1 loan for each €1 of your own money (a 1:1 leverage), you are still doubling the amount of money you have available for your trading.