What in the world is leverage?
Even though we have worked through this topic before, we feel that it is important enough to go over again.
The textbook definition of “leverage” is having the ability to control a large amount of money using none or very little of your own money and borrowing the rest.
The plain definition for leverage is being able to control a large amount of cash by borrowing most of it and only covering a little of it with your bankroll.
In Forex, you could have your broker set aside $1,000 dollars for you to control an entire $100,000 standard lot. Your leverage is now 100:1.
You have control over $100,000, while only owning $1,000 of it.
Now, let’s imagine that you owned the entire $100,000 and your account increases in value by $1000. You have now improved your bank roll by 1% (who cares, right?). That is what is known as a 1:1 leverage. Except, that isn’t the way you did it. You are 1:100 and that $1,000 profit doubled your bankroll. Awesome, right?
Now, imagine that instead of your account increasing by $1,000, it decreases by $1,000.
OMG, your balance is $0 and you’ve been going for what? An hour?
You have probably heard the term “leverage is a double edged sword” and now you understand why that’s true. Sure, the wins are great, but the losses will drain your account in an instant.
What on earth is margin?
Now, let’s go over what margin is and what it means to your account balance.
Let’s look at that example that we came up with earlier:
In Forex, you have your broker control $100,000 with a mere $1,000 set aside. Your leverage for this trade is 100:1.
The $1,000 that you gave your broker is considered “margin” – it is what you had to give up in order to get into the trade.
Your margin is the money you give to your broker as a deposit of good faith. The broker takes these margins from everyone and puts them together to be able to make huge trades on the interbank network.
Margin is normally seen as a percentage, and most brokers require between 2% and .25% margin to do a trade.
Looking at these figures, it is easy to figure out how much leverage you can put on a single trade.
If you have a broker that wants at least a 2% margin, then the best leverage you can get is 50:1. Here are the rest of the most seen leverage amounts that brokers offer.
|Margin Required||Maximum Leverage|
Other than the basic “margin required” amounts that are on the site, there are probably many other margin terms on your platform. These other terms can be confusing and I will do my best to clarify what all of them mean for you.
Required Margin: This will be the easiest term for you to understand because it is what we just went over. It is the amount of money you have to give as a deposit to get into a trade.
Usable Margin: This is all of the money you have in your trading account that can be used to open new trades with.
Account Margin: This is another way of saying “all of the money that you have in your account”…
Margin Call: This is a fail-safe that will close your position if the value drops below what you gave as your margin.
Used Margin: This is the amount of money that is already involved in other trades. It cannot be used to take out another trade.
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