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Leverage

Leverage is the ratio between the amount of the margin and the borrowed funds allocated for it: 1:100, 1:200, 1:500. The leverage of 1:100 means that a trader is required to have an amount in the trading acount which is 100 times less than the transaction sum.

The lending ratio is called the leverage. Its value may vary widely from 1:1 to 1:500. It means that a customer can buy/sell currencies in the amount exceeding the margin 500-fold! For example, if a trader chooses the 1:100 leverage and makes a deposit of $100, then he/she has the opportunity to purchase the currency for 100*100=$10,000. After buying a currency with a favorable change in the rate, a trader executes the sale, thereby deriving profit from currency rate fluctuations. In other words, a trader completes the transaction. At the moment of closing the trade, the credit automatically closes, the margin remains on the trader's account as well as the earned profit. This scheme allows traders to gain significant profits sometimes exceeding the amount of the margin involved in a certain transaction even with slight changes in foreign exchange rates. The trader's risk is limited only by the amount of the margin, as the dealing center does not provide the real amount of the opened transaction, but only guarantees the crediting of the loss or profit in full at the deal's closing. Closing a transaction is the opposite operation: when buying a certain amount of currency, the selling is doen in the same volume and vice versa.

The definition of the leverage is closely linked to the margin. Yet, at a closer look, there are differences between these two concepts. But for a seculator, the benefit is the same: the larger the leverage, the more is the ratio of his/her own funds and profitable speculative transactions. How does it affect the trading itself? Let us start with the history of the margin.

Initially, the margin trade principle was associated with transactions in the commodity markets. In the 19th century, the commodity exchanges were markets on which trades were carried out in cash. The brokers, who provided services for transactions' execution, transfers of money and account management, were the dealers in this market. The brokers maintained accounts using a special method of recording, the so-called "circle" recording. This method was the most efficient one to settle accounts between clients at frequent resales of goods. The circle method of calculations had been applied in the futures market up to the 1920s, as long as it met the needs. Within the framework of this method, the exchange members who were making the deals had to fulfill their obligations set by these contracts as participants of the agreement. They were the only ones to be responsible for the execution of deal obligations. Thanks to such a settlement system, clients did not need to deposit their own funds as a financial guarantee for the execution of an exchange contract and could enjoy trading at lower prices. The previous method of settlements was more advantageous when most of transactions were purely commercial, i.e. purchase and sale of contracts implied a real demand for goods or the good itself. The members of the exchange had to have substantial financial assets to guarantee the execution of obligations under any condition.


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