Forex Leverage & Margin Example - Leverage & Margin for Mini Account Explained

FX Leverage & Margin Explained

Margin required : It's amount of money your broker requires from you as a trader to open a trade. It is conveyed in percentages.

Equity : It's total amount of capital you've in your trading account.

Used margin : amount of money in your account which has been already used up when buying a currency contract, this contract is one that's displayed in open positions. You can't use this amount of money after opening a trade order transaction because you've already used it and it's not available to you.

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

Free margin : amount in your trading account that you can use to open new trade positions. This is amount of money in your trading account that hasn't yet been leveraged because you haven't 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. Broker at this point closes out all your trade transaction because if your transactions were to be left open they would lose the money you have borrowed from them.

This is why you should always make sure you have a lot of free margin. In order to do this as a trader never trade more than 5 percent of your account, in fact 2 percentage is recommended.

Difference Between Leverage Set by the Broker & Used Leverage

If the set leverage is 100: 1, it means that you can borrow upto $100 for every 1 dollar which you have in your account but you do not have to borrow all the $100 for every $1 you've, but you as a trader can decide to borrow 50:1 or 20:1. In this case even though the leverage option set 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 dollars (Equity)

Set 100:1

Leverage Used = Amount used /Equity

1 Mini Lot, 10,000 Mini Lot

If you buy one Mini lot which is equivalent to 10,000 dollars you'll have used

= 10,000/1000

= 10:1 leverage

0.5 Mini Lot, $5,000 Mini Lot

If you buy one 0.5 mini lots which is equal to 5,000 dollars you will have used

= 5,000/1000

= 5:1 leverage

0.2 Mini Lot, $2,000 Mini Lot

If you buy one 0.2 lots which is equal to 2,000 dollars you'll have used

= 2,000/1000

= 2:1 leverage

In these Three cases you can see that though the set maximum leverage is 100:1

The used leverage ratio is 10:1, 5:1 and 2:1 depending on the size of lots traded.

So Why not Just Choose 10:1 leverage option as the Maximum Leverage? Because to keep within the suitable risk management principles 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 funds referred to as 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 Trading.

In trading the security is referred to as margin. This is the capital which you deposit with your broker.

This is calculated in realtime as you trade. To keep your borrowed money you must sustain what is referred to as the required capital (your deposit).

Now if Your Trading Leverage is 100:1

When trading if you have $1,000 & use option 100:1 & buy 1 Mini lot for $10,000 your margin on this transaction is $1000 in your trading account, this margin is the money that you'll lose if your open trade transaction moves against you - the other $99,000 that is borrowed, the online broker will close the open trades automatically once your $1,000 has been taken by the market.

But this is if your online broker has set 0 percent Margin Requirements before stopping out your trades automatically.

For 20% margin requirement before stopping out your positions automatically, then your trades will be liquidated once your trading account balance reaches $200

For 50% margin prerequisite of this level before closing out your transactions automatically, then your trade transactions will be liquidated once your account balance gets to $500

If your broker sets 100% margin requirement of this level before closing out your open positions automatically, then your open trades will be automatically closed once your account balance gets to $1,000: Meaning that the trade will be closed-out as soon as you the trader executes it because even if you pay 1 pips spread your trading account balance will get to $990 & the needed percent is 100 percent i.e. $1,000 dollars, therefore your orders will immediately get stopped out out.

Most online brokers don't set 100% requirement, but there are those brokers who set 100% aren't suitable for you at all, choose those set 50% or 20% margin requirements, in fact, those brokers that set at 20% are some of the best because the likely hood they stop out-out your trade transaction is reduced as shown in above example.

To know about this margin level which is calculated by your MetaTrader 4 platform automatically - the MT4 Platform Software will illustrate this as "Margin Requirement", This will be displayed as a percentage the higher the percentage the less likely your transactions are to get stopped out.

For Examples if - (using a online broker that requires 20 % margin requirement)

Using 100:1 leverage

If leverage is 100:1 and you transact 10 Mini Lots, equals to $100,000

$100,000 divide by 100:1, your used funds is $1000

Calculation:

= Capital Used * Percentage(100)

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

Margin Requirement = 100 %

Investor has 80% above required margin trading level amount

Using 10:1

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

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

Calculation:

= Capital Used * Percentage(100)

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

Margin Requirement = 1000 %

Investor has 980% above required margin trading level amount

Using 1:1 leverage

If leverage is 1:1 and you transact 0.1 Mini Lot, equals to $1,000

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

Calculation:

= Capital Used * Percentage(100)

= $1,000/$10 * Percentage(100)

Margin Requirement = 10,000 %

Investor has 9800% above required margin trading level amount

Because when one has a higher leverage means that they have more margin requirement percent above what is required(A.K.A. More "Free Margin") their open trades are less likely to get liquidated. This is reason why traders will choose option 100:1 for their account but according to their risk management guidelines, they won't trade above 5:1 leverage option.

These Margin Levels are Shown on the MT4 Platform Screen Shot Below as an Example:

MT4 Software Margin and Free Margin - Leverage & Margin for Mini Account Explained