Leverage & Margin Trading Explanation & Example

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

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

Used margin : amount of money in your trading account which has already been used up when buying a stock indices contract, this contract is the one that's displayed in open trades. As a trader you can not use this amount of money after opening a trade because you have already used it & it is not available to you.

In other terms, because your broker has opened up a trade transaction for you using the capital you have borrowed, you must preserve this usable margin for your account as a collateral to allow you to continue using this leverage he has given you.

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

However, if you over use leverage, this free margin will drop below a certain % at which your broker will have to stop out all of your transactions automatically, leaving you with a big loss. The broker at this point closes out all your open trade position because if your open positions are left open they would lose the money that you've borrowed from them.

This is why as a trader should always make sure that you have a lot of free margin. To do this never trade more than 5 % of your account, in fact 2 % is recommended.

Difference Between Leverage Set by the Broker & Used Indices Leverage

If the set leverage is 100: 1, what it means is thatthat-as-a-trader you can borrow upto 100 dollars for every 1 dollar you have in your account, but you don't have to borrow all the $100 for every one dollar that you have, you can choose that you want to borrow 50:1 or 20:1. In this instance though leverage ratio is set at 100:1 your used leverage will be the 50:1 or 20:1 that you have borrowed to make a trade position.

Example:

You have $1000 (Equity)

Set 100:1

Stock Indices Leverage Used = Amount used /Equity

If you buy stock indices lots equal to $100,000 you will have used

= 100,000/1000

= 100:1

If you buy stock index trading lots equal to 50,000 dollars you'll have used

= 50,000/1000

= 50:1

If you buy stock indices lots equal to 20,000 dollars you'll have used

= 20,000/1000

= 20:1

In these 3 cases you can see that allthough the set is 100:1

The used is 100:1, 50:1, 20:1 depending on the size of stock indices lots traded.

So Why not Just Select 10:1 option as the Maximum Stock Indices Leverage? Because to keep within the suitable risk management guidelines it is even recommended that traders use less than this?

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

In stock indices the security is known as margin. This is the capital which you deposit with your broker.

This is calculated in real-time as you trade. To keep your borrowed amount you must preserve what is known-asreferred-to-as the required capital (your deposit).

Now if Your Leverage is 100:1

When trading, if you have $1,000 & use leverage ratio 100:1 & buy one standard lot for $100,000 your margin on this trade transaction is the $1000 dollars in your trading account, this is the money which you'll lose if your open trade transaction moves against you, the other $99,000 that's borrowed, they will close out the open stock indices transactions automatically once your $1,000 has been taken by the market.

But this is if your broker has set 0 % Stock Index Margin Requirement before closing out your stock trades automatically.

For 20% requisite before stopping out your stock index positions automatically, then your positions will be closed out once your balance gets to $200

For 50% requisite of this level before stopping out your stock index positions automatically, then your trade transactions will be stopped out once your balance gets to $500

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

Most brokers don't set 100 % requirement, but there are those who set 100% are not suitable for you at all, select those set 50 % or 20 % margin requirements, in fact, those brokers that set their margin requirement at 20% are some of the best because the likelyhood they close out your trade transaction is reduced as displayed in example above.

To know about this level which is calculated by your trading software automatically - the MT4 Stock Indices Software will display this as "Stock Index Margin Requirement", This will be displayed as a percent the higher the percentage the less likely your transactions are to get stopped out.

For Example if

Using 100:1

If leverage is 100:1 and you transact stock indices lots equal to $10,000

$10,000 divide by 100:1, your used capital is $100

Calculation:

= Capital Used * %(100)

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

Stock Index Margin Requirement = 1,000 %

Investor has 980 % above the required amount

Using 10:1

If leverage is 10:1 & you trade stock indices lots equal to $10,000

$10,000 dollars divide by 10:1, your used capital is $1000

Calculation:

= Capital Used * %(100)

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

Stock Index Margin Requirement = 100 percent

Investor has 80% above the required amount

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

These Zones are Shown on the Software Screen-Shot Below as an Examples:

MT4 Stock Indices Software