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What is Margin and Leverage in Forex?

19 May 2017 No Comment

In order to be involved in forex trading it is important to understand some of the terminology that is used. Margin and leverage are two terms that will come up every time you trade and here we will examine the terms and try to understand what they mean for your trading.

Margin

Margin is the amount of money you need to open a position with your broker. It is not a cost or fee, but rather money from your account that acts as a “good faith deposit” that the broker uses to hold open a position. The margin is generally expressed as a percentage of the full amount position. The margin size varies, but it may be 0.25%, 0.5%, 1% or 2%. The amount of margin needed will depend on the trade size so that as the trade size increases, your margin requirement will increase as well. Understanding what the margin is will help you to understand many terms surrounding your account which are used to described how much money your have available in your trading account; how much money is yours, but can’t be used as it has been locked up by your broker to keep any current positions of yours open and how much money is still available to you from your account that can be used to open new positions.

Leverage

Leverage comes about due to margin. Leverage is essentially a loan offered by a broker that allows traders to control larger trade sizes. Leverage is offered as a ratio with 100:1 meaning that the broker will offer 100 times the trader’s equity. So, if the trader spends $1,000, they will in fact control $100,000. Then, if the trade rises to $101,000, the trader will have made $1,000 – or 100% profit. On the other hand, if they lose $1,000, they will have lost 100%. In other words, leverage can both increase your potential for profits, as well as your potential for losses so traders need to control their leverage based on their trading strategy and original account size.

How Margin and Leverage are Related 

In the above example where the broker offers leverage of 100:1, if the trader is controlling $100,000 with $1,000, the $1,000 of equity is the margin. Therefore, the margin is the deposit or the amount that needs to be used in order to use leverage. Traders can generally work out the maximum amount of leverage they can use based on the margin that the broker requires. The higher the margin, the lower the leverage so for example, for 5% margin, the leverage will be 20:1; for a 1% margin, the leverage will be 100:1 and for 0.25% margin, the leverage will be 400:1.

A broker will generally use your margin and pool it together with the margins from other traders to create a “super margin deposit” that will allow them to place trades within the interbank network.

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