On one hand traders can exploit the maximum margin requirements that the broker-dealer provides, which can range from 100:1 to 400:1, but on the other hand we have the technical aspect of the mechanism. When asking what leverage you are using in your trading, you have to refer to the leveraged amount which you are effectively using to enhance your trading strategy.
The effective leverage is of paramount importance. There is nothing wrong in choosing the maximum level of leverage that the broker-dealer allows. What can put a trader in a dangerous situation is when the effective leverage comes close to the maximum displayed by the broker-dealer.
The effective leverage is calculated by dividing the value of open positions by the available balance of the account. In other words, the real leverage is the amount of capital you are really using compared to the amount in your account.
With a position worth of $20,000 (2 mini lots) and an account balance of $1,000, the real leverage is 20:1 (20.000/1.000 = 20). If this trade loses 50 pips, the account balance would go down by 10%. Remember, the pip value would be $2,00, multiplied by 50 pips, that is $100.
Should this loss happen, the real risk would increase with the next trade - now a loss of $100 is 11% of the account. This also means that the effective leverage rises even if the position size is kept the same, because the account balance is now lower. This is the typical dynamic of a losing spiral we mentioned when traders blow up their accounts - by doing the same, they lose more with each trade. This is because leverage increases each time.
To compound the issue, if the trader increases his/her leverage deliberately thinking in recovering losses faster, he/she is not acting in his/her best interest.
A leverage of 20:1 in a single position is quite high if we are to stay in the market for the long run. If our method is efficient in terms of consistency, then we can fine tune the leverage to get the maximum profit from it. This doesn't mean to exploit the maximum leverage offered by the broker-dealer, but instead, to use the maximum leverage that our method can sustain without the danger of a margin call.
For instance, you can have 5 open positions with an effective leverage of 4:1 each one. This way, you arrive at a leverage of 20:1 by adding 5 positions, and you will be eventually better protected with multiple positions over different currencies, than betting that leveraged amount in just one currency pair. The same leverage of 20:1 spread over several positions is a measure to diversify your risk.
How to bring this into practice will be discussed further when studying the development of trading systems and money management techniques. For now let's take one more step in the appliance of the mechanics you have just learned.
Margin Trading
When conducting a Forex transaction, you are not actually buying all that currency and depositing it into your account. Technically, you are speculating on the exchange rate and contracting with your broker-dealer that they will pay you, or you will pay them, depending if the exchange rate moves in your favor or not.
A trader who purchases a USD/JPY standard lot does not have to put down the full value of the trade (100,000 USD). But to gear up the trade size to institutional level, the buyer is required to put down a deposit known as "margin". The minimum deposit capital varies from broker to broker and can range from $100 to $100,000.
That is why margin trading can be seen as trading with borrowed capital– it's basically a loan from the broker-dealer to the trader, but based on the trader’s deposited amount. Margin trading is what allows leverage.
In the above example, the trader's initial deposit serves as a guarantee (a collateral) for the leveraged amount of 100,000 USD. This mechanism insures the broker-dealer against potential losses. As you see, you are not using the deposit as a payment or purchase of currency units. It is rather a good-faith deposit, made by the trader to the dealer or broker.
When executing a new trade, a certain percentage of the deposit in the margin account will be frozen as the initial margin requirement for the new trade. The quantity of required margin per trade depends on the underlying currency pair, its current exchange rate and the number of lots traded. Remember, the lot size always refers to the base currency. The frozen initial margin requirement may not be used in trading until the trade is closed.
The more positions are opened simultaneously the more margin is required until it eventually becomes a notable percentage of your account.
Margin Call - a Guaranteed Limited Risk
In the futures market, a losing position may go beyond the deposited margin, and the trader will be liable for any resulting deficit in the account. In Forex this will not happen as the risk is minimized through the mechanism of a "margin call".
Most online trading platforms have the capability of automatically generating a margin call when your margin deposits have fallen below the required minimum level because an open position has moved against you.
In other words, when the losses exceed the deposit margin, all open positions will be closed immediately, regardless of the size of positions held within the account. http://www.fxstreet.com/
Margin and Leverage
Concept of Leverage
A very extended and poor definition of leverage is that it's a tool that will help traders earn money fast and easy. And indeed, one of the most important advantages of the Forex market is given by the effect of leverage! Without leverage, it would be very difficult to accumulate capital by trading the market, especially for small investors. But leverage can also be very harmful if not properly understood. This duality is what makes this concept difficult to grasp and explains partly why there are so many misconceptions about it.
Financial leverage, meaning a purchase on a margin, is the only way for small investors to participate in a market that was originally designed only for banks and financial institutions. Leverage is a necessary feature in the Forex market not only because of the magnitude of capital required to participate in it, but also because the major currencies fluctuate on average less than 2% per day.
Without leverage, the Forex would not attract capital from the retail sector. It is designed to allow a greater market share to investors in accordance with their investment capacity.
Leverage is therefore a form of credit or loan, which allows us to trade with money from the broker-dealer. Financial leverage is also defined as the use of foreign capital per unit of capital invested.
In fact, the mechanism of leverage is what enables the existence of broker-dealers. They also have accounts in different banks which serve them as liquidity providers, thus acting as lenders of first resort for the broker-dealer's margin transactions. This means that the bank allows the broker-dealer to trade with larger amounts of capital and the broker-dealer, in turn, transfers this benefit to the user. The capital deposited in the bank guarantees limited risk, as does your deposit with the broker-dealer.http://www.fxstreet.com/
Margin and Leverage
Lots and Position Sizes
In Forex the minimum amount of currency you have to buy is called one "lot". That means that units of currencies are grouped and traded in lots. At a retail level, lots are divided into several categories: the so-called "full-size" or "standard" lots, "mini" lots, "micro" lots and "flexible" or "fractional" lots.
A standard lot consists of 100,000 units of whatever the base currency in the currency pair is. A mini lot consists of 10,000 units of the base currency and a micro lot 1,000 units of the base currency.
As you can see, a mini contract is one-tenth the size of a standard contract and the micro lot one-tenth of the mini lot.
Flexible lots, in turn, allow the trader to choose the exact amount of units of the base currency to buy or sell.
Differentiated by the lot sizes there are also several types of accounts that a trader can open with a retail broker-dealer. While a standard account controls 100,000 units per lot traded, a mini account and a micro account control one lot size lower respectively.
So for instance, when buying one micro lot on the GBP/USD, you would buy 1,000 British Pounds and sell an equivalent amount of US Dollars.
Let's suppose the current exchange rate for GBPUSD is 2.4500 and you want to buy 10,000 US Dollars worth of this pair. Here's the math:
For pairs with USD as the quote currency, take the Dollar amount you want to purchase and divide it by the exchange rate:
(desired position size) / (current rate) = # of units
that is:
10,000 US Dollars / 2.4500 = 4081.63 units of GBPUSD
As you can see, this is approximately 4 mini lots of British Pounds. If your broker-dealer doesn't offer fractional lot sizes you can always round up or down.
Buying a pair with USD as the base currency is much easier to calculate. Why? Because in these cases you just buy the amount of units you want because you are purchasing US Dollars, the base currency.
And in the case of a cross pair transaction, when buying 10,000 US Dollar worth of GBPCHF, for instance, we purchase 4081.63 units of GBPUSD at the above rate and sell 10,000 units of USDCHF.
Being able to choose among several lot sizes is a huge advantage retail Forex trading offers to the small investor. It allows you to tailor and fine tune your money management to better meet your trading style.
If you have a very small account size keep your risk profile low by choosing a dealer that offers micro or fractional lot sizes. Even many seasoned traders avoid standard contracts to be more precise in their position sizing. We will extensively talk about position sizing and money management in other units of the Learning Center.
NZD (New Zealand Dollar) - Major characteristics
This currency behaves similar to the AUD because New Zealand's economy is also trade oriented with much of its exports made up of commodities. The NZD also moves in tandem with commodity prices.
As per estimates from the last BIS triennal survey, in 2007 the NZD accounted for a daily transaction share volume of 1,9% of total Forex transactions, after the Norwegian krone, the Hong Kong Dollar and the Swedish krone.
Along with the Australian Dollar, the NZD has been for many years a traditional vehicle for carry traders, which has made this currency also very sensitive to changes in interest rates. In 2007 the NZD was mainly used to conduct carry trades against the Japanese Yen accounting for a higher volume than the Australian Dollar against the Yen. Fxstreetdotcom.
Major characteristics the AUD (Australian Dollar)
Australia is a big exporter to China and its economy and currency reflect any change in the situation in that country. The prevailing view is that the Australian Dollar offers diversification benefits in a portfolio containing the major world 
currencies because of its greater exposure to Asian economies. This correlation with the Shanghai stock exchange is to be added to the correlation it has with gold. The pair AUD/USD often rises and falls along with the price of gold. In the financial world, gold is viewed as a safe haven against inflation and it is one of the most traded commodities. Together with the New Zealand Dollar, the AUD is called a commodity currency. Australia's dependency on commodity (mineral and farm) exports has seen the Australian Dollar rally during global expansion periods and fall when mineral prices slumped, as commodities now account for most of its total exports.
The interest rates set by the Reserve Bank of Australia (RBA) have been the highest among industrialized countries and the relatively high liquidity of the AUD has made it an attractive tool for carry traders looking for a currency with the highest yields. These factors made the AUD very popular among currency traders. It's the 6th most traded currency in the world accounting for an estimated 6.8% of worldwide FX transactions in 2007, far in excess of the economy's importance (2% of global economic activity). Fxstreetdotcom
The AUD is under a free floating regime since 1983. Before that it was pegged to a group of currencies called the trade weighted index (TWI).
Major characteristics: CAD (Canadian Dollar)
Canada is commonly known as a resource based economy being a large producer and supplier of oil. The leading export market for Canada is by far the United States making its currency particularly sensitive to US consumption data and economical health.
Being a highly commodity dependent economy, the CAD is very correlated to oil - meaning that when oil trends higher, USD/CAD tends to trend lower and vice versa.fxstreetdotcom
If Canada is one of the world's largest producers of oil and is such a big part of the US economy, rising oil prices tend to have a negative effect on the USD and a positive effect on the CAD. Here you have two nice correlations.
But if you are willing to find a pair which is really sensitive to oil prices, then pick the CAD/JPY. Canada and Japan are at the extreme ends of production and consumption of oil. While Canada benefits from higher oil prices, Japan's economy can suffer because it imports nearly all of the oil it consumes. This is another interesting correlation to follow..
CHF (Swiss franc)- major characteristics:
Several factors such as a lengthy history of political neutrality and a financial system known for protecting the confidentiality of its investors, have created a save heaven reputation for Switzerland and its currency. Being the worlds largest destination of offshore capital.
The Swiss franc moves primarily on external events rather then domestic economic conditions, and is therefore sensitive to capital flows as risk-averse investors pile into Franc-denominated assets, during global risk aversion times. Also much of the debt from Eastern European economies is denominated in Swiss Francs.
JPY (Japanese Yen)- major characteristics:
The Japanese Yen, despite belonging to the third most important single economy, has a much smaller international presence than the Dollar or the Euro. The Yen is characterized by being a relatively liquid currency 24 hours.
Since much of the Eastern economy moves according to Japan, the Yen is quite sensitive to factors related to Asian stock exchanges. Because of the interest rate differential between this currency and other major currencies that preponderated for several years, it is also sensitive to any change affecting the so-called "Carry Trade". Investors were then shifting capital away from Japan in order to earn higher yields. However, in times of financial crisis when risk tolerance increases, the Yen is not used to fund carry trades and is punished accordingly. When volatility surges to dangerous levels, investors try to mitigate risk and are expected to park their money in the least risky capital markets. That means those in the US and Japan.
The concept of carry trade will be disclosed later in this chapter, but a short definition would be: a strategy which involves buying or lending a currency with a high interest rate and selling or borrowing a currency with a low interest rate.
Japan is one of the world's largest exporters, which has resulted in a consistent trade surplus. A surplus occurs when a country's exports exceed its imports, therefore an inherent demand for Japanese Yen derives from that surplus situation. Japan is also a large importer and consumer of raw materials such as oil. Despite the Bank of Japan avoided raising interest rates to prevent capital flows from increasing for a prolonged period, the Yen had a tendency to appreciate. This happened because of trade flows. Remember, a positive balance of trade indicates that capital is entering the economy at a more rapid rate than it is leaving, hence the value of the nation's currency should rise. Fxstreetdotcom
In some countries the fiscal year and calendar year are not identical. In Japan the start of a new fiscal year is April 1st. Japanese companies usually ‘dress up’ their balance sheets ahead of the fiscal year-end, by liquidating foreign holdings and bringing home the profits from overseas subsidiaries, in order to raise their bottom lines. This capital flows prior to the start of the new fiscal year, and the fact that banking trading desks lower their transaction volumes, condition the exchange rates and price action in all pairs containing the Yen.
EUR (Euro) - The major characteristics
The European Monetary Union is the world's second largest economical power. The Euro is the currency shared by all the constituting countries which also share a single monetary policy dictated by the European Central Bank (ECB).
This currency is both a trade driven and a capital flow driven economy. Before the establishment of the Euro, central banks didn't accumulate large amounts of every single European national currency, but with the introduction of the Euro it is now reasonable to diversify the foreign reserves with the single currency. This increasing acceptance as a reserve currency makes the Euro very susceptible to changes in interest rates.
The effect of the Euro competing with the Dollar for the role of reserve currency is misleading. It gives observers the impression that a rise in the value of the Euro versus the US Dollar is the effect of increased global strength of the Euro, while it may be the effect of an intrinsic weakening of the Dollar itself.Fxstreetdotcom
Nickname: Fiber or Single Currency
USD (US Dollar) - The major characteristics
The US Dollar is by far the most transacted currency in the world. This is due to several factors as you have already learned in the last chapter. First, it's the world's primary reserve currency, which makes this currency highly susceptible to changes in interest rates. Second, the USD is a universal measure to evaluate any other currency as well as many commodities such as oil (hence the term "petrodollar") and gold.
Today's other major currencies like the Euro, the British Pound, the Australian Dollar and New Zealand Dollar are moving against the American currency, and so do the Japanese Yen, the Swiss franc and Canadian Dollar.
70% of the U.S economy depends on domestic consumption, making its currency very susceptible to data on employment and consumption. Any contraction in the labor market has a negative effect on this currency.
All US Dollar denominated bank deposits held at foreign banks or foreign branches of American banks are known as "Eurodollars". Some economists maintain that the overseas demand for Dollars allows the United States to maintain persistent trade deficits without causing the value of the currency to depreciate and the flow of trade to readjust. Other economists believe that at some stage in the future these pressures will precipitate a run against the US Dollar with serious global financial consequences.FXStreet.com
Exchange Rate
The concept of buying and selling capital can be confusing because you're not buying anything in exchange for money, like you do in the stock market, for example. Instead you are simultaneously buying one currency and selling another.
In the stock market, traders buy and sell shares; in the futures market, traders buy and sell contracts; in the Forex market, traders buy and sell "lots". When you buy a currency lot, you are speculating on the value of one currency compared to another, on the exchange rate itself.
Currencies are traded in pairs. The pair is written in a particular format, best demonstrated by way of two examples. The Euro and the US Dollar: EUR/USD or the British Pound and the Japanese Yen: GBP/JPY.
Imagine if currencies would be traded single and you would want to buy 100 US Dollars. Do you think it would be easy to find someone offering more than 100 Dollars for the same amount? Probably not. The value of a currency does not change in itself, what changes is its value in relation to other currencies. This is a characteristic of a free floating exchange rate system, as you learned in the previous chapter.
If you hear another trader saying "I'm buying the Euro", he/she is expecting that the value of the Euro will rise against the US Dollar and speculates by buying the EUR/USD exchange rate. The trader's ability to anticipate how the exchange rate will move will determine if the trade will represent a win or a loss.
The first member of every pair is known as the "base" currency, and the second member is called the "quote" or "counter" currency. The International Organization for Standardization (ISO) decides which currency is the base and which one is the quote within each pair.
The exchange rate shows how much the base currency is worth as measured against the counter currency. For example, if the USD/CHF rate equals 1.1440, then one US Dollar is worth 1.1440 Swiss francs. Remember, the value of the base currency is always quoted in the counter currency member within the pair (hence the name "quote currency"). A simple rule to understand the exchange rates would be to think of the base currency as one unit of that currency being worth the value of the exchange rate expressed in the quote currency.
Following the example above, one US Dollar is worth 1.1440 Swiss Francs.
Therefore, any unrealized profit or loss is always expressed in the quote currency. For example, when selling 1 US Dollar, we are simultaneously buying 1.1440 Swiss francs. Likewise, when buying 1 US Dollar, we are simultaneously selling 1.1440 Swiss francs.
We can also express this equivalence by inverting the USD/CHF exchange rate to derive the CHF/USD rate, that is:
CHF/USD = (1/1.1440) = 0.874
This means that the quote of one Swiss franc is 0.874 US Dollars. Note that CHF has now become the base currency and its value is accrued in USD.
In spot Forex, not all pairs have the US Dollar as the base currency. Primary exceptions to this rule are the British Pound, the Euro and the Australian and New Zealand Dollar.
GBP/USD, EUR/USD, AUD/USD, NZD/USD
When looking at a chart you can see if a currency pair, or in other words, the exchange rate between two currencies, is rising or falling.
In the above example the chart illustrates the strength of the base currency, the Euro, relative to the quote currency, the US Dollar. Remember, the quote currency is the one in which the exchange rate is quoted. 
The next chart shows the same base currency but this time relative to the Australian Dollar. Both charts comprise the same period and as you can see, the value of the Euro has shown a different behavior towards the USD than towards the AUD.
In a free floating system, there are two main factors that can affect exchange rates every day: international trade (import/export of commodities, manufactured goods and services) and capital flows (following certain interest rates, equity performance, government debt instruments like bonds).
It is by buying and selling a currency, therefore exchanging it with other currencies, that it becomes stronger or weaker, independently from the fact that this transaction was speculative or not.
Currencies reflect the performance and policies of entire economies, sovereign governments and industry. It is the comparison of different currencies and their economies that drives exchange rates up and down.
Basically there are two main methods to estimate where a currency is heading: the fundamentals and price action.
The first refer to the economic and political factors that influence the value of currencies, such as the release of economical data and news. The second are graphical representations of the exchange rates like you see above. Graphs show offer and demand levels and price patterns which can be recognized visually. And as a numerical sequence, prices can be also technically analyzed using mathematical formulas. -fxstreet.com
Trading Forex : is in fact like trading entire economies. A huge difference compared to equities - where companies are traded - is that trends in Forex can last very long. Due to the fact that macroeconomic events can continue to influence the market over a time frame of months and years, an economy that is weak tends to stay weak for a long time. A company that is in trouble can be turned around fairly quickly, but not an entire economy.
Many retail traders feel the need to buy and sell bottoms on the charts, hopping for a turn-around, but the fact is that a currency that has been weakening can always go lower in value, and one that has been gaining strength can always go higher too. The lesson here is that if you want to fight trends in the Forex world, be sure to have a sound and tested method able to capitalize on such circumstances.