Forex Leverage & Margin Trading Explanation & Examples

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

Equity : It's the total amount of capital you have in your forex account.

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

In other words, because your forex broker has opened up a forex trade position for you using the capital you have borrowed from the broker, you must maintain this usable margin for your account as a security to allow you to continue using this leverage that the broker has given you.

Free margin : amount in your forex account which you can use to open new forex trade positions. This is the amount of money in your forex account that has not yet been leveraged because you have not yet opened forex trade transactions with this money - this is also very important for you as a investor because it enables you to continue holding your open forex trades as will be described below.

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

This is why you should always make sure you have a lot of free margin in your forex trading at all times when trading forex. To do this never trade more than 5 percent of your forex account, in fact trading 2 percent of your forex account is what is recommended.

Difference Between Forex Leverage Set by the Broker & Used Leverage

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

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 equal to 100,000 dollars you will 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 dollars you will 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 dollars 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 equal to 10,000 dollars you will have used

= 10,000/1000

= 10:1

In these three cases you can see that even though the set forex trading leverage is 100 : 1

The used is 100:1, 50:1, 20:1 and 10:1 depending on the size of forex lots traded.

So Why not Just Select 10:1 option as the Maximum Leverage for Your Forex Account? Because to keep within the proper risk management rules it is even recommended that traders use less than this?

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

In forex trading the security is known as margin. This is the capital you deposit with your forex 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 must maintain what is known as the required capital (your deposit).

Now if Your FX Trading Leverage is 100:1

When trading if you have $1,000 & use leverage option 100:1 and buy 1 standard forex lot for $100,000 your forex margin on this transaction is the $1000 dollars in your forex account, this is the money that you will lose is your open forex trade transaction goes against you - the other $99,000 that is borrowed from you forex broker, they (your forex broker) will close the open forex trade transactions automatically once your $1,000 has been taken by the market.

But this is if your forex broker has set 0% Margin Requirement before closing your forex trades automatically.

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

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

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

Most forex brokers do not set 100% Margin requirement, but there are those forex brokers that set Margin requirement at 100% and these brokers aren't suitable for you at all, choose those forex brokers that set 50% or 20% margin requirements, in fact, those brokers who set it at 20% are some of the best because the likely hood they close-out your open forex trade is reduced as shown in example above.

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

For Example if

Using 100:1

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

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

Calculation:

= Capital Used * Percentage(100)

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

Margin Requirement = 1,000 %

Investor has 980% above required amount

Using 10:1

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

$10,000 dollars(mini lot) divide by 10:1, your used trading capital is $1000

Calculation:

= Capital Used * Percentage(100)

= $1,000/$1000 * Percent(100)

Margin Requirement = 100 %

Investor has 80% above required amount

Because when a trader has a higher leverage means that they have more percent above what is required(A.K.A. More "Free Margin") their open transactions are less likely to get closed. This is reason why traders will choose option 100:1 for their forex account but according to their forex trading risk management rules, they will not trade above 5:1.

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

Margin and Free Margin is displayed by the MT4 Forex Software