What is leverage?
Leverage can be applied to tasks including purchasing a house. A mortgage allows you to pay 20% of the purchase price and borrow 80% of the price from a bank. Borrowing capital enables you to purchase a home without having to have all the money you need to cover the purchase price.
Similarly, leverage that is used in the capital markets allows you to borrow funds to place a trade. Your broker will lend you capital and your collateral (the repayment if you can’t repay the loan), is the value of the currency pair.
For example, a broker might ask you to place 5% on a EUR/USD trade with a notional value of $10,000. You must have a minimum of $500 in your account to make the transaction. You can borrow $9,500 and make a $10,000 trade, as opposed to a trade with a total value of $500. Leverage in forex trading thus enhances levels of capital.