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How Does Forex Leverage Work?

by Tom Nunamaker on January 25, 2012

in Education

bird wondering how many Euros she can buy

How does Forex Leverage work?

A friend has been trading forex recently and the topic of leverage came up.  The Commodity Futures Commission (CFTC) ruled in October 2010 that the maximum leverage available to U.S. Residents is 50:1.  My friend and I both use interactive brokers, which offers leverage of 40:1 but he didn’t think he was getting 40:1 leverage.

How does leverage work?

Currencies are quoted in pairs.  The first currency is what you are buying or selling.  The second currency is what you are buying and selling the first currency with. Here’s a few examples:

GBPUSD  means you are buying or selling the British Pound and you are paying for them with US Dollars

EURUSD means are you buying or selling Euros and paying for them with US Dollars

How about an example?

If the exchange rate for the GBPUSD is quoted at 1.5000 then every British Pound costs $1.50 US Dollars.  If your account has US Dollars in it, you have to do a little math:

Cash in Account  x  40  = Cash available for margin  / exchange rate = Amount of Foreign Currency you can buy.

If you have a $10,000 Forex account, at 40:1 leverage, you could trade $400,000 USD of currencies.  If you wanted to purchase GBP and the exchange rate is 1.5000, you could buy $400,000 / 1.5 = 266,667 GBP

A short cut is to take the leverage and divide it by the exchange rate.  For example, for 40:1 leverage and trading the EURUSD at a 1.3000 exchange rate:

40 / 1.3 = 30.76

Your $10,000 account could purchase just over 300,000 Euros.

Check your broker to see what leverage they offer and now you can calculate know how much of any currency you can trade with.

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