Forex Leverage & Margin Trading Example - Forex Leverage & Margin for Mini Account Explained
Forex Leverage & Margin Explained
Margin required : It's amount of money your Forex broker requires from you to open a position. It is expressed in percents.
Equity : It's total amount of capital you've in your account.
Used margin : amount of money in your trading account which has already been used up when buying a currency contract, this contract is one that is displayed in open positions. As a trader you can't use this amount of money after opening a trade order transaction because you have already used it and it is not available to you.
In other words, because your broker has opened up a position for you using capital you have borrowed, you must maintain this usable margin for your trading account as a security to allow you to continue using this leverage he has given you.
Free margin : amount in your account that you can use to open new trade positions. This is amount of money in your account that has not yet been leveraged because you have 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 trades as will be explained below.
However, if you over use leverage, this free margin will drop below a certain percent at which your broker will have to close all your positions automatically, leaving you with a big loss. Broker at this point closes all your position because if your positions are left open they would lose the money you have borrowed from them.
This is why you should always make sure you've a lot of free margin. To do this never trade more than 5 percent of your forex account, in fact 2 percent is recommended.
Difference Between FX Trading Leverage Set by the Forex Broker and Used Forex Leverage
If the set leverage is 100: 1, it means that you can borrow up to 100 dollars for every dollar which you have in your forex account but you don't have to borrow all the 100 dollars for every dollar you've, but you 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.
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 equal to 10,000 dollars you will 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 will have used
= 2,000/1000
= 2:1 leverage
In these 3 cases you can see that even though the set maximum leverage is 100:1
The used leverage is 10:1, 5:1 and 2:1 depending on the size of forex lots traded.
So Why not Just Select 10:1 option as the Maximum Leverage? Because to keep within the proper risk management rules it is even recommended that traders use less than this?
This question may seem straight forward but it is not, because when you trade you use borrowed money known A.K.A. 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 Forex Trading.
In forex trading the security is known as margin. This is the capital you deposit with your forex broker.
This is calculated in real time as you trade. To keep your borrowed money you must maintain what is known as the required capital (your deposit).
Now if Your FX 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 dollars in your forex account, this margin is the money that you will lose if your open trade transaction goes against you - the other $99,000 that is borrowed, the broker will close the open trade transactions automatically once your $1,000 has been taken by the market.
But this is if your forex broker has set 0% Margin Requirement before closing your trades automatically.
For 20% margin requirement before closing your trades automatically, then your trade transactions will be closed once your account trading balance gets to $200
For 50% margin requirement of this level before closing your trades automatically, then your trade transactions will be closed once your account trading balance gets to $500
If your FX broker sets 100% margin requirement of this level before closing out your open trades automatically, then your open trades will be automatically closed once your trading 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 account balance will get to $990 and the needed percent is 100% i.e. 1,000 dollars, therefore your orders will immediately get closed out.
Most brokers do not set 100% requirement, but there are those brokers who set 100% aren't suitable for you at all, select those set 50% or 20% margin requirements, in fact, those brokers who set it at 20% are some of the best because the likely hood they close-out your trade is reduced as shown in example above.
To know about this margin level which is calculated by your MT4 platform automatically - the MetaTrader 4 Platform will display this as "Margin Requirement", This will be displayed as a percentage the higher the percentage the less likely your trades are to get closed.
For Examples if - (using a 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 dollars divide by 100:1, your used capital 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 dollars divide by 100:1, your used capital 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 & you transact 0.1 Mini Lot, equals to $1,000
$1,000 dollars divide by 100:1, your used trading 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 a trader has a higher leverage means that they have more margin requirement percent above what is required(A.K.A. More "Free Margin") their open forex trade transactions are less likely to get closed. This is reason why traders will choose option 100:1 for their forex trading account but according to their risk management rules, they will not trade above 5:1.
These Margin Levels are Shown on the MetaTrader 4 Software Screen Shot Below as an Example:
MetaTrader 4 Platform Margin & Free Margin - Forex Leverage & Margin for Mini Account Explained
