Leverage & Margin Explanation and Examples

Margin required : It's amount of money your broker requires from you to open a trade transaction position. It is denoted/expressed in percentages.

Equity : It's the total sum of capital you have on your trading account.

Used margin : amount of money on your account which has already been used when buying a currency lot, this contract is one that is illustrated and displayed in open position transactions. As a trader you as a trader can not use this amount of money after opening a trade transaction because you have already used it & it is not available to open other trades.

In other terms, because your online broker has opened up a trade position for you using the capital you have borrowed from the broker, you must maintain this usable margin for your trading account as a collateral to allow you as the trader to continue using this leverage that the online broker has issued you.

Free margin : amount in your trading account which you as a trader can use to open new trades. This is the amount of money on your account that has not yet been leveraged because you haven't yet opened trade positions with this money - this is also very important for you as a investor and trader because it facilitates you to continue holding your open trades as will be explained below.

However, if you over use leverage, this free margin will drop below a certain percent at which your broker will be forced to close all your open positions mechanically/automatically, leaving you with a large loss. The broker at this point closes out all your position because if your open trades are left open they would lose the money you have borrowed from the online broker.

This is why you should always ensure you've got a lot of free margin in your trading at all times when trading forex. In order to do this as a trader never trade more than 5 % of your account, in fact 2 percent of your account is what is recommended.

Difference Between Forex Leverage Set by the Broker and Used Leverage

If the set leverage ratio is 100 : 1, it means you as a forex trader can borrow up to 100 dollars for every dollar you have on your account but you do not have to borrow all the 100 dollars for every dollar you have on your account and you as a forex trader can decide to borrow 50:1 or 20:1 leverage. In this case even though the leverage option set 100:1 your used leverage will be the 50:1 or 20:1 leverage that you've borrowed to make a trade.

Example:

You have $1000 dollars (Equity)

Set leverage is 100:1

Leverage Used = Amount used /Equity

1 Contract, $100,000 Lot

If you buy one standard forex lot which is equivalent to 100,000 dollars you'll have used

= 100,000/1000

= 100:1

0.5 Contract, $50,000 Mini Lot

If you buy one 0.5 lots which is equal to $50,000 you'll have used

= 50,000/1000

= 50:1

0.2 Contract, $20,000 Mini Lot

If you buy one 0.2 lots which is equal to $20,000 you will have used

= 20,000/1000

= 20:1

0.2 Contract, $10,000 Mini Lot

If you buy one 0.1 lots which is equivalent to 10,000 dollars you'll have used

= 10,000/1000

= 10:1

In these three cases you as a trader can see that even though the set leverage is 100 : 1

The used leverage option is 100:1, 50:1, 20:1 and 10:1 depending on the position size of lots traded and transacted.

So Why not Just Choose 10:1 leverage option as the Maximum Leverage for Your Account? Because to keep within the suitable risk management guidelines it is even advised that traders use lesser than this?

This question may seem straight forward but it is not, because when you trade you use borrowed money known as Leverage. When you borrow capital from anyone or a bank you as a trader must maintain security/collateral to get a loan, even if the collateral is depending and based on the monthly deduction from your own salary, same thing with FX Trading.

In fx trading the security is known as margin. This is the capital which you deposit with your online broker.

This is calculated in real time as you trade - as you open and close trades this free margin is calculated. To keep your borrowed money you as a trader must maintain what is referred to as required capital (your deposit).

Now if Your Leverage is 100:1

When trading if you as a trader have $1,000 & use leverage ratio 100:1 & buy 1 standard forex lot for $100,000 your margin on this transaction is the $$1000 in your account, this is the money that you'll lose out if your open trade position goes against you : the other $99,000 that's borrowed from you broker, they (your broker) will close the open trades mechanically/automatically once your $1,000 has been taken out by the market.

But this is if your broker has set 0% Margin Requirements before liquidating your trade positions mechanically.

For 20% Margin requirement before closing your transactions automatically/mechanically, then your open trades will be closed once your account balance gets to $200

For 50% Margin requirement of this free margin level before closing your open forex positions mechanically/automatically, then your open trades will be closed once your account balance gets to $500

If your broker set 100% Margin prerequisite of this level before closing out your open positions automatically/mechanically, then your trade will be closed once your account balance gets to $1,000: Meaning the trade that you'll open will close out as soon as you execute it because even if you pay 1 pip spread your trading account balance will get to $990 & the needed Margin requirement percentage level is 100 percent i.e. $1,000, hence your open position orders will immediately get closed.

Most online brokers do not set 100% Margin requirement, but there are those brokers that set Margin requirement at 100% and these brokers aren't suitable for you at all, choose those brokers who set 50% or 20% margin requirements, in fact, those brokers that set at 20 % are among some of the best since due to and because of the likely hood they stop out-out your open trade is reduced and minimized such as displayed in above illustration.

To know about this margin requirement level which is calculated by your platform automatically - The MetaTrader 4 Platform Software will display this as "Margin Requirement", This will be displayed as a percentage the higher the percentage the less likely your open trades are to get closed.

For Example if

Using 100:1

If leverage ratio is 100:1 & you transact 1 Mini Lot, equals to $10,000

$10,000 (mini lot) divided by 100:1, your used funds is $100 dollars

Calculation:

= Capital Used * Percentage

= $1,000/$100 * Percent(100)

Margin Requirement = 1,000 %

Trader and Investor has 980 % above the requirement amount

Using 10:1

If leverage is 10:1 & you transact 1 Mini Lot, equals to $10,000

$10,000 (mini lot) divided by 10:1, your used funds is $1000

Calculation:

= Capital Used * Percentage

= $1,000/$1000 * Percentage

Margin Requirement = 100%

Investor and Trader has 80 % above the required sum

Because when a forex trader has a higher leverage means that they have more % above what is required(A.K.A. More "Free Margin") their open trade positions are less likely to get stopped out. This is reason why traders will choose option 100:1 for their account but in accordance to their trading risk management rules, they won't trade above 5:1 leverage ratio.

These Margin Levels are Shown on the Software Screen Shot Below as an Example:

Leverage & Margin - Maximum Leverage and Used Leverage

Margin and Free Margin is displayed by the MetaTrader 4 Software

More Topics:

Trade Forex Trading

Leverage & Margin Explanation and Examples

Difference Between Forex Leverage Set by the Broker and Used Leverage

Now if Your Leverage is 100:1