Most brokers provide leverage to investors and traders alike. So what is leverage?
The textbook definition of "leverage" is having the ability to control a large amount of money using none or very little of your own money and borrowing the rest.
For example, you deposit $10,000 in your trading account. You buy 2 standard 100K lots of EUR/USD at a rate of $1.0000. The full value of your position is $200,000 and your account balance is $10,000. Your true leverage is 20:1 ($200,000 / $10,000)
Let's say you buy another 2 standard lots of EUR/USD at the same price. The full amount of your position is now $400,000, but your account balance is still $10,000. Your true leverage is now 40:1 ($400,000 / $10,000)
Let’s say the price of EUR/USD increased by 2% to $1.0200. Your 4 standard lots of EUR/USD will now be worth $408,000. If you closed the position, you would have made $8,000 in profits which equates to a 80% profit.
However, suppose the price of EUR/USD fell by 2% to $0.9800. Your 4 standard lots of EUR/USD will now be worth $392,000. If you closed the position, you would have made a loss of $8,000, depleting your account by a whopping 80%!
Your profit/losses are calculated using the following:
(true leverage used) x (% change in market price)
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