The concept of margin and leverage is a simple but extremely important concept you need to understand before you start trading the forex market. By not understanding leverage and margin, many traders under-capitalize their account or over trade it.
This is especially true if you are demo trading and trying to translate your demo trades to a live account. Many beginner traders place as many trades as they can on demo accounts because they can open them with thousands of dollars, but when they try to trade the same on a live account, they realize that they do not have the funds to trade the same.
Leverage and margin requirements will vary from broker to broker and country of operation but before you open a live account consult with your broker and know specifically what the rules are.
What is Margin in Trading
Let’s look at a few key terms all traders need to know before they begin trading.
- Margin required: It is the amount of money that is held by the broker when you place a trade. It varies per currency pair per broker.
- Account margin: This is the total amount of money you have in your account to trade with.
- Used margin: This is the amount of money that is tied up in open positions. It is the combination of all the open trades that you have.
- Usable margin: This is the remaining amount of money you have available outside of your open trades. Account margin – Used Margin.
- Margin call: This happens when your margin falls below the margin you have available. At this time, the broker will close all open trades at the current price the market is at, winning and losing trades.
- Margin Level: Is the Equity divided by used margin, it’s used by traders within their trading accounts to leverage more of their investment.
Example: If your broker provides you 50:1 leverage, then for every $1,000 you put in, you can control $50,000. This will also affect the amount of margin required to place a trade. If the margin to execute a trade on a standard lot is $2,000, it would be $200 for a mini lot and $20 for a
What is Leverage in Trading and How to Use it
In trading, we monitor the currency movements in pips, which is the smallest change in currency price, and that could be in the second to the fourth decimal place of a price depending on the currency pair. These movements are really just fractions of a cent.
For example, when a currency pair like the GBP/USD moves from 1.2200 to 1.2300, that is a 100 pip movement which is just a one cent move of the exchange rate.
That is why leverage is important in the forex market. It allows these small price movements to be translated into decent profits when magnified through the use of leverage. When you deal with a large amount like $50,000, small changes in the price of the currency can result in significant profits or losses. Leverage allows individuals to control large trade sizes with little capital.
Leverage Ratio and Minimum Margin Requirements
Leverage is expressed as a ratio and is based on the margin requirements imposed by your broker. For example, if your broker requires you to maintain a minimum 2% margin in your account, this means that you must have at least 2% of the total cash available in your account before you can plan any trade order. Once again, this varies from broker to broker, so make sure you contact your broker to get this type on information.
As a trader, it is important to understand both the pros and cons of trading with leverage. Using the 50:1 ratio as an example, this means that it is possible to enter into a trade for up to 50 dollars for every dollar in the account.
Once again by using leverage, you can have access to a $50,000 position with $1,000 in your account and potentially earn the profits of a $50,000 position. Keep in mind, you also face the risk of losing funds based on a $50,000 trade as well. Traders suffering a loss without sufficient margin remaining in their account run the risk of triggering a margin call.
All of this is why it is very important to do the necessary studying, homework, research and practice before you begin trading so that you are not making mistakes that could have been easily avoided.