What exactly is leverage ratio? A must-know mechanism of forex trading for traders

The Core Difference Between Leverage and Leverage Ratio

Many beginner traders often confuse leverage with leverage ratio. In simple terms, leverage is a borrowing trading mechanism, while the leverage ratio is a numerical indicator measuring the strength of this mechanism.

The operation principle of leverage is quite straightforward: you don’t need to put up all your trading capital. As long as you pay a portion of the margin to the broker as collateral, you can borrow the remaining funds to control a larger trading position. This is why the forex market attracts a large number of traders—the mechanism of leveraging small capital to control big positions maximizes capital efficiency.

So what exactly is the leverage ratio? Simply put, it represents the ratio of your total controllable trading funds to your actual invested capital. For example, a 1:100 leverage ratio means that with 1 dollar invested, you can control a trading amount of 100 dollars.

Types of Leverage Ratios and Their Relationship with Margin Requirements

Here’s an intuitive logic: the lower the margin requirement, the higher the leverage ratio you can use.

Suppose you want to buy EUR/USD at the current quote of 1.36837. Buying 1 lot (100,000 USD) requires a trading principal of 126,837 USD. Different brokers have different margin requirements:

• Margin requirement of 1% (leverage 1:100): need to pay 1,268 USD
• Margin requirement of 0.5% (leverage 1:200): need to pay 634 USD
• Margin requirement of 2% (leverage 1:50): need to pay 2,537 USD

Brokers usually adjust leverage ratios based on the volatility risk of currency pairs. For currency pairs with high volatility, brokers tend to increase margin requirements and reduce available leverage.

Practical Calculation of Leverage Trading

Numbers can sound a bit dry, so let’s look at a concrete example.

Suppose you buy EUR/USD with 1:200 leverage, at the current quote of 1.26837, requiring only 634 USD in margin to hold a position worth 126,837 USD.

The key point: Your profit or loss is calculated based on the entire position value, not just your invested margin.

If EUR/USD rises 30 points to 1.26867, your profit is: (1.26867 - 1.26837) × 100,000 = 300 USD

In other words, you invested 634 USD and earned 300 USD, with a return of up to 47%.

But what if it goes the other way? If EUR/USD drops to 1.26707, a 130-point decline, your loss would be: (1.26707 - 1.26837) × 100,000 = 1,300 USD

This is disastrous—you invested 634 USD but lost 1,300 USD, wiping out your principal.

Leverage Is a Double-Edged Sword, Combining Risks and Rewards

This is the true face of leverage. Leverage can amplify your profits when the market moves favorably, but it also magnifies your losses when the market moves against you, potentially wiping out your entire capital and even owing money.

A 100-point move with 1:200 leverage might result in hundreds of dollars of profit or loss, but without leverage, the loss might only be a few dollars. This is the leverage amplification effect.

Therefore, novice traders need to be aware: the higher the leverage ratio, the greater the risk exposure. If you’re not yet familiar with using leverage, it’s advisable to start practicing with lower leverage ratios, gradually adapting to market volatility.

The key is to find a leverage ratio that suits your risk tolerance—one that allows you to fully utilize the advantages of capital leverage without risking a single loss that could wipe you out.