Lesson 13: The Difference Between Margin and Leverage

If you’ve been trading for a long time now, the concept of margin and leverage probably excites you. But how about the confused beginners? 

Novice traders often use them interchangeably, and most of the time, they don’t know what these terms mean. The concepts of margin and leverage can be a headache if you’re not yet familiar with them. 

Simply put, leverage is only possible with margin. In trading terms, you use margin trading to leverage your trade.

Lesson Highlights

• Margin and leverage are two different concepts used in margin trading. The former refers to the capability, while the latter is the mechanism for accessing and controlling a leveraged position.
• Leverage is the broker's quantifier for traders to control positions bigger than their deposit. Meanwhile, the margin is the trader's deposit that the broker requires to open, control, and maintain a position.

Is Leverage the Same as Margin?

Leverage is not the same as margin. Yes, both terms work together; however, they don’t share the same meaning.  

Look at leverage as the capability and margin as the mechanism.

Simply put, leverage lets you trade a larger position than what you have in your account. It magnifies the size of your position. Meanwhile, margin is the collateral or deposit you use to open and maintain the leveraged position.  

Look at Jabari’s margin trade and see how leverage and margin take action.

Jabari is a first-time forex trader. He wants to enter the market but doesn’t want to risk a big chunk of his investment. His trader friend suggested looking for a broker offering high-leverage margin trading.  

After finding the right broker, he goes long EUR/USD with a notional value of USD 100,000. Thanks to the 20:1 leverage offered by his broker, he managed to join the market with only a USD 5,000 margin. 

What Is Margin Trading? 

As you’ve learned from the previous lesson, margin trading is when you borrow funds from your broker to enter a trade. 

When trading on margin, you must put up a specific amount of money to open a position called margin. This required margin acts as your collateral or deposit for the leveraged trade.  

If your margin position is open, the required margin should remain unused. If it loses, you must lock the required margin in your trading account to support your open trade.

The margin must be relatively smaller than the notional value of the position you want to control. 

What Is Leverage 

While margin is the deposit, leverage is what you use to magnify your margin to enter a much bigger trading position.

Margin traders see leverage as buying power that the broker bestowed upon them.

Leverage is the ratio between the money you have and the amount you can trade.

If you’ve been searching for online trading, you’ve probably come across these ratios:

• 100:1
• 50:1 
• 25:1 
• 20:1 
• 10:1 

These are the common leverages offered by online brokers to their respective clients. These are expressed as a ratio representing the multiplier that magnifies your required margin. 

To get the value of your leverage, you need to know your broker’s margin requirement for your desired currency pair. Here are the common margin requirements for the major pairs: 

Broker and Leverage 

Now, you might be asking why your broker gives you the power of leverage.  

Is this simply a noble gesture of your broker? Or, do they benefit from your margin trading as much as you do? 

Promoting leveraged trading is one way for your broker to amplify their trading position and increase their profits.  

Here are a few reasons why offering leverage benefits your broker.  

1. Increased Trading Volume. This means more commissions and spread for the broker. 
2. Interest Rates. The interest rates the broker gets from margin trading are an additional revenue stream for the company.  
3. Attracting Traders. A leveraged position is attractive to traders as it lets them make more profit with only a small amount of capital. Margin trading allows brokers to market their services and attract potential clients.  

Okay, you’re settled with the definition of leverage and margin now. In the next lesson, you’ll walk through the margin jargon you need to know before you trade on margin.