What are Leverage & Margin in Trading?
Leverage, also known as margin trading, empowers traders to control larger positions with less capital, thereby magnifying both profits and losses. By utilizing leverage, traders can amplify their trading volume compared to their available margin.
The use of leverage significantly enhances the potential for both gains and losses. For instance, without leverage, buying the EUR/USD at 1.0000 would require the price to reach zero for a total loss or 2.0000 to double the investment. However, with full 100:1 leverage, a price movement 100 times smaller would yield the same profit or loss.
Margin refers to the capital that a trader must allocate to initiate a new position. It is not a fee or cost and is released once the trade is closed. Its primary purpose is to safeguard the broker from potential losses. If a trader’s margin falls below a predetermined stop-out percentage due to losses, the broker automatically closes one or all open positions. Prior to such liquidation, the broker may or may not issue a margin call warning.
Understanding How Leverage Works
With 100:1 leverage, a trader can open a position that is 100 times larger than what would be possible without leverage. For example, if the cost to open a trading position of 0.01 lots of EUR/USD is $1,000 without leverage, a broker offering 100:1 leverage would only require the trader to use $10 as margin. Traders also have the flexibility to utilize lower leverage ratios, such as 30:1 or 5:1, or even opt for no leverage at all.
Caution: Higher leverage ratios entail higher risks. Professional traders generally employ lower leverage ratios, such as 5:1 or none at all, while adhering to a modest risk percentage per trade (2%).
Using the Leverage & Margin Calculator
Instrument: Traders can select from various forex crosses, including major and minor pairs, as well as popular cryptocurrencies (ADA, BTC, DOGE, ETH, LTC, Stellar, Ripple, etc.), renowned indices, and commodities like Gold, Silver, and Oil. For this example, let’s choose the EUR/USD.
Deposit Currency: Margin requirements differ for different forex pairs and financial instruments and are subject to market quotes. By selecting the deposit currency, the calculator will accurately display the margin needed to open a position in the chosen currency (ranging from AUD to ZAR). In this case, let’s choose GBP as the deposit currency.
Leverage: Simply input the desired leverage ratio in this field. It can be the leverage currently offered by the broker or any other ratio, ranging from as little as 1:1 to 6000:1, to simulate the margin required for position opening. For our example, we will select a leverage of 30:1.
Lots (Trade Size): Enter the lot size for the trade. In the forex market, 1 lot equals 100,000 currency units, but the units per lot may vary for non-forex pairs. The calculator provides the option to switch between lots and units for precise calculations. Let’s use a trade size of 0.10 for this example.
Finally, click the Calculate button.
The results: Based on the provided data, the Leverage & Margin Calculator informs us that to open a long or short trade position of 0.10 lots of EUR/USD with 30:1 leverage, and considering the current EUR/GBP exchange rate of 0.90367, a margin of 301.22 GBP would be required.