Leverage and Fundamental Forex

Forex is the foreign exchange marketplace where currencies from different countries are valued and exchanged. Forex trades almost $2 trillion per day, a total that exceeds all of the world’s biggest and better-known markets.

There are two major methods for analyzing the forex trading -- fundamental and technical. Fundamental analysis relies upon a ‘broad and near-expert understanding of multi-national macroeconomic statistics and events’.

Here the traders believe that the value of a pair of currency is determined by the underlying health of the two nations involved in the pair. For example, a high value for GBP/USD, would suggest a better economic outlook in Britain and the United States. Global events like news, catastrophes, politics or economic shocks, play a role in determining price.

In forex, the dealers have ultimate control over accounts and trade and are willing to loan money to the trader. It is known as margin or leverage, which is basically a loan from the dealer to the trader, but based on the trader’s equity. Normally if you want to trade EUR/USD, you would need $100K, but not if the dealer offers margin.

When you trade one contract with $500 in margin, you control $100,000. Here the leverage is 200:1. Most dealers have scaling margin that allows smaller accounts to use something like 200:1 and bigger accounts to use 50:1, or 10:1. The concept of leverage is extremely fundamental in the forex trading, as because of this, most of the trader earns their profit and most of them lose too.

Fundamental analysis is often used to get an overview of currency movements and to provide a broad picture of economic conditions affecting a specific currency. Most of the traders rely on technical analysis for plotting entry and exit points into the market and supplement their findings with fundamental analysis.

The carry trade is a strategy in which a trader sells a currency that is offering lower interest rates and purchases a currency that offers a higher interest rate. In other words, you borrow at a low rate, and then lend at a higher rate. The trader using the strategy captures the difference between the two rates. When highly leveraging the trade, even a small difference between two rates can make the trade highly profitable.

Leverage can be dependant of fundamental factors like world event. In the past we have experienced geopolitical events affecting the leverages offered by the dealers. With leverage, you can greatly increase the return.

For example, 10 times leverage would create a return of 30% on a 3% yield. If you have $1,000 to start your account and have access to 10 times leverage, you can control $10,000. If you implement the carry trade you earn 3% per year. At the end of the year, your $10,000 investment would equal $10,300, or a $300 gain.

Because you only invested $1,000 of your own money, your real return would be 30% ($300/$1,000). However this only works if the currency pair’s value remains unchanged or appreciates. Therefore, most carry traders look not only to earn the interest rate differential, but also capital appreciation.

To learn more about the brokers who offer the best leverage and spreads visit our Forex Broker Review page