Best Leverage for Standard Account - Forex Leverage and Margin Trading Explanation and Example

Forex Leverage and Margin Explained

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

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

Used margin : amount of money in your trading account that 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 not 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 trades. This is amount of money in your account which hasn't 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've 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 Forex Trading Leverage Set by the FX Broker and Used Leverage

If the set leverage is 100: 1, it means that you can borrow up to 100 dollars for every dollar that you have in your forex account but you do not 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 10,000 dollars (Equity)

Set 100:1

Leverage Used = Amount used /Equity

1 Contract, 1 Standard Lot

If you buy one standard lot which is equal to 100,000 dollars you will have used

= 100,000/10,000

= 10:1

0.5 Contract, $50,000 Standard Lot

If you buy one 0.5 lots which is equal to 50,000 dollars you will have used

= 50,000/10,000

= 5:1 leverage

0.2 Contract, $20,000 Standard Lot

If you buy one 0.2 lots which is equal to 20,000 dollars you will have used

= 20,000/10,000

= 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 investors 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 monthly deduction from your salary, same thing with Forex Trading.

In forex trading the security is known as margin. This is capital you deposit with your 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 in your forex account and use leverage option 100:1 and buy 1 standard lot for $100,000 - your margin on this transaction is the $1,000 dollars in your forex Standard 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 trades 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 percent level requirement level before automatically closing your open trade positions, 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 execute it because even if you pay 1 pips spreads your trading account balance will get to $990 and the needed percent is 100% i.e. 1,000 dollars, therefore your trade orders will immediately get closed out.

Most brokers do not set 100% requirement, but there are those brokers who 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 because the likely hood they closeout your trade is reduced as displayed in the example above.

To know about this margin level which is calculated by your MT4 platform automatically - the MT4 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 1 Standard Lot, equals to $100,000

$100,000 dollars(Standard lots) divide by 100:1, your used capital is $1000

Calculation:

= Capital Used * Percentage(100)

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

Margin Requirement = 100 %

Investor has 80% above required margin trading level amount

Using 10:1

If leverage is 10:1 and you transact 0.1 Standard Lots, 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 and you transact 0.01 Standard Lot, equals to $1,000

$1,000 dollars 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 a trader has a higher leverage means that they have more margin requirement percent above what's required(A.K.A. More "Free Margin") their open forex trade transactions are less likely to get closed. This is reason why traders will select 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 MT4 Software Screen Shot Below as an Example:

MetaTrader 4 Platform Margin and Free Margin - Forex Leverage and Margin for Standard Account Explained