Trading Leverage: Understanding How It Works in Forex and CFD Markets

One of the fundamental reasons new and professional traders turn to the forex and CFD markets is leverage. 

Come to think of it, using borrowed funds to control a larger underlying asset or position means that you can commit a relatively small initial investment but take on a much larger market exposure. 

When used correctly, leverage enables traders to diversify across currency pairs, indices, and commodities, opening opportunities that would otherwise be out of reach. However, the same mechanism isn't without its downsides. 

This guide demystifies how leverage works, explains the leverage ratio, shows real‑world examples from forex and CFD trading, and explores strategies for risk management in leveraged trading.

What Is Leverage in Trading?

In short, leverage in trading means controlling a position that is larger than your own capital by using borrowed funds provided by a broker. 

If you've seen anything like 20:1 or 100:1, etc, when trying to open a trading account, that's leverage. In this case, a ratio of 20:1 means that for every $1 of your own money, you can control $20 worth of a financial instrument. 

Brokers provide this facility through a margin account; they set aside a percentage of the position’s value as a margin requirement, while the rest is effectively a loan.

Margin vs. Leverage

Although the terms margin and leverage are sometimes used interchangeably, they refer to different aspects of the same mechanism. 

Margin is the deposit you must put down to open a leveraged trade. It represents a fraction of the trade’s total value. For example, if you open a position worth $40000 in EUR/USD and the broker requires a $2000 margin, your leverage ratio is 20:1 (40000 ÷ 2000). 

Leverage is the degree to which your trade’s total exposure compares with your own funds. A higher leverage ratio means a smaller margin requirement and greater sensitivity to price changes. 

Brokers often offer different margin requirements for different instruments. For instance, most major currency pairs often require between 2% and 5% of the notional value as margin.

How Leverage Works in Forex Markets

Forex markets are some of the most liquid in the world, with major currency pairs trading 24 hours a day and price changes often measured in fractions of a cent. This liquidity allows brokers to offer higher leverage ratios compared with stock or commodity markets. 

Forex trading commonly offers ratios up to 30:1 for the most widely traded pairs, while stock trading might start at 5:1. Some brokers outside Europe offer ratios of 100:1 or even 1000:1. For instance, Switch Markets offers a high leverage of 1000:1, which is among the highest in the industry. 

So, how does it work? Let’s say you buy a standard lot of EUR/USD at 1.10 using a 3% margin. That means you’ll need to deposit roughly $3300 to control a $110000 position, giving you about 33:1 leverage. A 1% move in the currency pair translates to a gain or loss of about $1000 on the margin. After a comparatively small adverse move, the broker may close the position if no additional funds are added. 

This is a classic example of how leverage can magnify both returns and losses.

Margin Calls in Forex

Since leverage and margin calls are always used around one another, let's define what a margin call is. 

When a leveraged trade moves against you, the broker may issue a margin call, requesting additional funds to maintain the required margin level. In other words, a margin call is a broker’s demand for additional funds or securities when the account’s equity falls below the required maintenance level. 

Most brokers automatically close positions if equity falls to 100% or less of the required margin at a specified time, and close all positions if equity drops to 25% or less.

How Leverage Works in CFD Trading

To understand how leverage works in CFD trading, let’s consider a recent example using gold. As of now, gold trades around US$4,127.80 per troy ounce. 

In the CFD market, positions are often measured in lots rather than individual ounces. A standard lot typically represents 100 troy ounces of gold, though the exact amount can vary between brokers. For those who are confused about lot size, we recommend visiting our guide on lot size in trading. 

So, suppose you buy one standard lot of gold through a CFD at the current market price of $4,127.80 per ounce. The notional value of this position is therefore $412,780 (100 × $4,127.80). However, with 20:1 leverage, you are only required to deposit a 5% margin, or $20,639, to open the trade. This means that with a relatively modest outlay, you can control a much larger position.

If gold’s price rises or falls by just 1%, the value of your position changes by $4,127.80. In relation to your margin, that 1% market move produces a 20% gain or loss on your deposit. A small shift in price can therefore have a significant effect on your account balance.

In regions where much higher leverage, such as 200:1, is permitted, the margin required for the same position would fall to just $2,063.90. The notional value of the position remains unchanged, so the same 1% move in gold would still equal a $4,127.80 gain or loss, now amounting to nearly 200% of your initial margin.

Pros and Cons of Using Leverage

Here are the pros and cons of using leverage in the forex and CFD markets:

How to Calculate Margin Requirements and Leverage Ratios

An important part of leverage trading is determining how much margin is required to open a position and how much leverage you are using. Brokers usually state margin requirements as a percentage. You can convert margin requirement to leverage ratio using the formula:

Maximum Leverage Ratio = 1 ÷ Margin Requirement

If your broker requires a 5% margin on a commodity CFD, your maximum leverage is 20:1 (1 ÷ 0.05). If the margin requirement is 3%, leverage is 33:1 (1 ÷ 0.03). Remember that leverage should not be used to its maximum simply because it is available; risk tolerance and strategy should drive the decision.

Margin Calls and Risk Management

When a margin call arrives, you must act quickly. It's either you add funds to restore your margin or reduce your position. Some brokers provide a short window to meet the call, while others liquidate positions immediately. 

Maintaining a buffer above the minimum margin and using stop‑loss orders reduces the likelihood of receiving a margin call in the first place.

Prudent risk management is the cornerstone of sustainable leveraged trading. Traders should start with modest leverage, especially when new to a market, and gradually increase exposure as experience and confidence grow. 

Stop‑loss orders are essential because they cap potential losses at a predetermined level; AvaTrade stresses that these orders should never be skipped. Determining how much of your capital to risk on any single position, often 1% or less, prevents any one trade from having an outsized impact on your account. 

Finally, diversification, regular review of market conditions, and choosing a regulated broker with negative balance protection all help mitigate the risks of margin calls and amplified losses.

How to Choose the Right Leverage Ratio

This is the one million dollar question - how much leverage should you use? 

The answer - There is no universal “best” leverage ratio; the appropriate level depends on your strategy, market conditions, and risk tolerance. 

Short‑term traders such as scalpers sometimes employ higher leverage to capture small price fluctuations, but they also use tight stop‑loss orders, or a trailing stop-loss order, and close positions quickly. 

Swing and position traders who hold trades for days or weeks typically opt for lower leverage because overnight news events and financing costs can significantly affect returns. 

However, we advise that volatile markets like gold or cryptocurrencies should be traded with minimal leverage, while more stable currency pairs can accommodate higher ratios. 

Ultimately, experienced traders may be comfortable with moderate leverage, whereas newcomers should adopt conservative ratios and focus on learning the market.

Short-term traders may use higher leverage to capitalize on small price moves, relying on tight or trailing stop-losses and quick trade exits to control risk. In contrast, swing and position traders generally prefer lower leverage, since holding trades overnight exposes them to news-driven volatility and additional financing costs.

10 Unbreakable Laws of Trading With Leverage

Here are key rules traders must keep in mind when trading with leverage:

How To Use Leverage With Switch Markets

Switch Markets’ default leverage for major pairs can be as high as 1000:1, which means you only need to deposit 0.1 % of the position value as margin. However, our dynamic leverage system offers even higher leverage on small positions. 

For example, if you open a 3‑lot position on USD/JPY, the first 0 – 5 lots qualify for 1:1000 leverage and require just US$300 of margin. As the trade size increases beyond 5 lots, the leverage automatically steps down to 1:500 and then to 1:200. This tiered approach ensures that larger positions carry progressively lower leverage and therefore lower risk.

Dynamic leverage is a flexible model that tailors your leverage to trading volume, account equity, and market volatility. It offers high leverage for small trades and automatically reduces leverage as you increase your lot size or as volatility picks up. 

Importantly, dynamic leverage is instrument‑specific: major forex pairs can receive up to 1:1000 leverage for 0 – 5 lots, metals up to 1:500, indices up to 1:200, and oil up to 1:100. The system is applied automatically on the Switch Markets platform, so you don’t have to recalculate margin tiers yourself. 

Wrapping Up

Choosing the right leverage ratio is as much about trading psychology and strategy as it is about regulatory limits. Scalpers might opt for higher leverage to capture small intraday moves, whereas position traders should lean toward lower ratios to withstand overnight volatility. 

No matter your style, avoid excessive leverage, be aware of the costs associated with maintaining positions, and always be prepared to add additional funds or exit positions swiftly if the market turns against you.

Traders who respect leverage, understand the risks involved, and practice sound risk management can harness it to pursue their financial goals. Those who ignore its dangers risk significant losses that can exceed their initial investment. 

As you trade, remember to approach leveraged trading with caution, learn continuously, and never risk more than you can afford to lose.

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FAQs

If you still have lingering questions about leverage, the following FAQ addresses some of the most common questions.

What is the maximum leverage Switch Markets offers?

Professional clients can access fixed leverage of up to 1:1000 on major and minor currency pairs. Our dynamic leverage also provides up to 1:1000 for the first 0 – 5 lots of major forex positions. This leverage, however, is not available to EU clients.

How does dynamic leverage differ from fixed leverage?

Fixed leverage remains constant regardless of position size, but dynamic leverage automatically adjusts based on trade volume, account equity, and market volatility. It offers higher leverage for small trades and gradually decreases leverage as positions grow, helping to manage risk.

Does dynamic leverage apply to all instruments?

No. Dynamic leverage is available for forex pairs, metals, indices, and oil. It is not applied to CFDs on digital currencies, shares, or ETFs.