Explanation of Leverage and Margin

Let's talk about the differences between leverage and margin.

What exactly is leverage？

We know we've talked about this before, but it's such an important topic that we felt compelled to bring it up again.

The textbook definition of “leverage” is the ability to control a huge sum of money by borrowing the remainder and using none or very little of your own money.

To manage a $100,000 position, for example, your broker will set aside $1,000 from your account. Your leverage, measured in terms of ratios, is now 100:1.

With $1,000, you now have control of $100,000.

Let's imagine your $100,000 investment grows to $101,000, or $1,000.

Your return would be a meager 1% ($1,000 gain / $100,000 primary investment) if you had to come up with the remaining $100,000 cash alone.

This is often referred to as 1:1 leverage.

Of course, I believe that 1:1 leverage is a misnomer because where is the leverage in having to come up with the entire amount you're trying to control？

You're not leveraged 1:1, but you are leveraged 100:1.

Your return is a groovy 100 percent ($1,000 gain / $1,000 primary investment) because the broker only had to put away $1,000 of your money.

We'd want you to undertake a little exercise now. Calculate how much you'd get back if you lost $1,000.

You would have gotten a -1 percent return using 1:1 leverage and a WTF! -100 percent return using 100:1 leverage if you calculated it the same way we did, which is also known as the right way.

You've probably heard phrases like “Leverage is a two-way street” or “Leverage is a double-edged sword.”

These clichés weren't lying, as you can see.

What exactly is a margin？

So, what exactly is a “margin”？ That is an excellent question.

Let's return to the previous example:

To manage a $100,000 position in forex, your broker will deduct $1,000 from your account. Your leverage, as measured by ratios, is now 100:1. With $1,000, you now have control of $100,000.

You had to put down a $1,000 deposit as “margin” in order to get the job.

The amount of money required as a “good faith deposit” to initiate a position with your broker is known as margin.

Margin is usually expressed as a percentage of the position's total value. Most forex brokers, for example, state that they need a margin of 2%, 1%,.5%, or.25 percent.

You may calculate the highest leverage you can use with your trading account based on the margin needed by your broker.

You have a leverage of 50:1 if your broker requires a 2% margin.

Other popular leverage “flavors” presented by most brokers include:

You'll probably find more “margin” terminology in your trading platform besides “margin need.”

Because there is a lot of misunderstanding about what these various “margins” entail, we'll do our best to describe each term:

Margin is required:

Because we already discussed it, this is a simple one. It's the amount of money you'll need to create a position with your broker. It's calculated in percentages.

Your trading bankroll is referred to as your account balance. It refers to the entire quantity of funds in your trading account.

The amount of money that your broker has “locked up” to keep your present positions open is known as used margin.

While this money is still yours, you won't be able to touch it until your broker returns it to you, either when you manually cancel your current positions or when your broker closes a trade for you.

Usable margin is the amount of money in your account that can be used to open fresh trades.

When the amount of money in your account is insufficient to cover your potential loss, you will receive a margin call.

When your equity goes below your utilised margin, this happens.

If your broker issues a margin call, you will be asked to deposit additional funds into your account. If you don't, the broker will close any or all of your open positions at market price.