You’re probably tired of reading about margin and leverage at this point. However, as these two trading concepts are among the top causes of trade losses, you’ll hear more about them in the following lessons.
Margin and leverage are so instrumental in your trades that it’s worth—imperative, even—discussing them more than once.
This lesson will serve as a refresher course about these two concepts and, hopefully, a reminder of how leverage and margin can make or break your profits.
Lesson Highlights
- Leverage lets you control large positions using only a small part of your trading account balance.
- Margin affects how much leverage you can use.
- Leveraged losses can quickly bankrupt your trading account if you don’t have risk management measures.
What Is Leverage?
Leverage is what lures many traders toward the forex market. Unlike stocks, the leverage forex brokers offer is much higher, even going as high as 3000:1.
But what exactly does leverage mean?
In forex trading, leverage refers to your ability to control a large position (a huge amount of money) using only a small portion of your own funds, if at all.
When you trade with leverage, the bulk of the money you use to control your positions will come from your broker. The amount of money you gain access to through leverage varies with each brokerage firm.
Some brokers offer a 50:1 leverage ratio, some have 200:1, while others even entice traders with a whopping 3000:1 leverage.
As you can see in the table below, your leverage ratio dictates how much controlling power your funds will have.
Account Balance | Leverage Ratio | Max Position Size |
USD 1,000 | 50:1 | USD 50,000 |
100:1 | USD 100,000 | |
200:1 | USD 200,000 | |
500:1 | USD 500,000 | |
1000:1 | USD 1,000,000 | |
3000:1 | USD 3,000,000 | |
USD 2,5000 | 50:1 | USD 125,000 |
100:1 | USD 250,000 | |
200:1 | USD 500,000 | |
500:1 | USD 1,250,000 | |
1000:1 | USD 2,500,000 | |
3000:1 | USD 7,500,000 |
Using leverage, every USD 1 in your account balance will have its value multiplied by 50, 100, 200, etc., depending on the ratio your broker gives.
Leverage’s multiplying power lets you substantially increase the size of your positions and magnify your possible profits and losses.
What Is Margin?
Margin is closely related to leverage. It refers to the amount of funds you need to open a position. You can think of margin as a sort of collateral – it assures your broker that you can afford to hold your position until it’s closed.
For instance, suppose you want to open a long position in EUR/USD with a position size worth USD 100,000. If your broker offered you a 50:1 leverage with a 2% margin requirement, you’ll have to have at least USD 2,000 in your trading account balance as a margin to proceed with the trade.
This means that your broker will set aside USD 2,000 (2% of your USD 100,000 position size) from your account balance before letting you access the 50:1 leverage.
You can calculate the maximum leverage your broker offers depending on the margin required.
Margin Requirement | Maximum Leverage |
0.25% | 400:1 |
0.50% | 200:1 |
1.00% | 100:1 |
2.00% | 50:1 |
3.00% | 33:1 |
5.00% | 20:1 |
How Do Leverage and Margin Affect Your Trades?
Leverage and margin trading are effective trading tools you can use to drastically increase your possible profits, even without a substantial balance in your trading account.
However, what many inexperienced traders tend to forget is that these tools work both ways. Leverage and margin can significantly amplify the returns you can get from your trades, but they can backfire and give you massive losses instead.
Leveraged losses can quickly wipe your capital if you don’t have risk mitigation measures in place (e.g., stop-loss orders).
In the next lesson, you’ll learn more about the drastic effects of ignoring leverage.
