Stock Leverage and Margin Trading Explanation & Example

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

Equity : It is total amount of capital you have in your trading account.

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

In other words, because your stocks broker has opened up a trade position for you using the capital you've borrowed, you must preserve this usable margin for your trading account as a collateral to allow you to continue using this stocks leverage he has given you.

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

However, if you over use stocks leverage, this free trading margin will go below a certain percent at which your stocks broker will have to close out all of your transactions automatically, leaving you with a big loss. The stock 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 you should always make sure you've a lot of free margin. ToIn-order-to do this as a trader never trade more than 5 percent of your stock account, in fact 2 percentage is recommended.

Difference Between Stock Leverage Set by the Broker & Used Stocks Leverage

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

Example:

You have 1000 dollars (Equity)

Set 100:1

Stocks Leverage Used = Amount used /Equity

If you buy stocks lots equal to 100,000 dollars you'll have used

= 100,000/1000

= 100:1

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

= 50,000/1000

= 50:1

If you buy stocks trading 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 stocks lots traded.

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

This question might seem straight forward but it's not, because when you trade you use borrowed money known A.K.A. Stocks Leverage. When you borrow trading 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 Stocks.

In stocks the security is known as margin. This is capital you deposit with your broker.

This is calculated in realtime as you trade. To keep your borrowed money you must maintain what is known as required capital (your deposit).

Now if Your Stock Leverage is 100:1

When trading if you have $1,000 and use leverage option 100:1 & buy 1 standard lot for $100,000 your margin on this transaction is $1000 dollars in your account, this is money that you'll lose if your open trade transaction goes against you the other $99,000 that is borrowed, they will stop out the open stocks positions automatically once your $1,000 has been taken by the stocks market.

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

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

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

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

Most brokers don't set 100% requisite, but there are those that set 100% are not suitable for you at all, select those set 50% or 20% margin requirements, in fact, those brokers that set it at 20% are some of the best since due to the likely hood they stop out your trade transaction is reduced as displayed in the example above.

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

For Example if

Using 100:1

If stocks leverage is 100:1 & you transact stocks lots equal to $10,000

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

Calculation:

= Capital Used * Percent(100)

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

Stock Margin Requirement = 1,000 %

Investor has 980% above the required amount

Using 10:1

If stocks leverage is 10:1 & you transact stocks lots equal to $10,000

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

Calculation:

= Capital Used * Percent(100)

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

Stock Margin Requirement = 100 %

Investor has 80% above the required amount

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

These Levels are Shown on The Software Screen-Shot Below as an Examples:

MetaTrader 4 Stock Platform