Leverage & Margin Explanation & Examples

Margin required : It's amount of money your broker requires from you to open a trade transaction position. It's expressed in percents.

Equity : It's the total sum of capital you have 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 is displayed in open trade positions. As a trader you can not use this amount of money after opening a trade because you have already used it and it is not available to open other trades.

In other words, because your online broker has opened up a trade position for you using the capital you have borrowed from the broker, you must maintain this usable margin for your account as a collateral to allow you to continue using this leverage that the broker has given you.

Free margin : amount in your trading account which you can use to open new trade positions. This is the amount of money in your account that has not yet been leveraged because you have not yet opened trade transactions with this money - this is also very important for you as a investor because it enables you to continue holding your open trades as will be described below.

However, if you over use leverage, this free margin will drop below a certain % at which your broker will have to close all your open trade positions automatically, leaving you with a big loss. The broker at this point closes out all your position because if your open trade positions are left open they would lose the money you have borrowed from the broker.

This is why you should always make sure you have a lot of free margin in your trading at all times when trading forex. In order to do this as a trader never trade more than 5 % of your account, in fact 2 percent of your account is what is recommended.

Difference Between Forex Leverage Set by the Broker and Used Leverage

If the set leverage ratio is 100 : 1, it means you can borrow up to 100 dollars for every dollar you have in your account but you do not have to borrow all the 100 dollars for every dollar you have in your account and you can decide to borrow 50:1 or 20:1 leverage. In this case even though the leverage option set 100:1 your used leverage will be the 50:1 or 20:1 leverage that you have borrowed to make a trade.

Example:

You have $1000 (Equity)

Set leverage is 100:1

Leverage Used = Amount used /Equity

1 Contract, $100,000 Lot

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

= 100,000/1000

= 100:1

0.5 Contract, $50,000 Mini Lot

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

= 50,000/1000

= 50:1

0.2 Contract, $20,000 Mini Lot

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

= 20,000/1000

= 20:1

0.2 Contract, $10,000 Mini Lot

If you buy one 0.1 lots which is equal to 10,000 dollars you will have used

= 10,000/1000

= 10:1

In these three cases you can see that even though the set leverage is 100 : 1

The used leverage ratio is 100:1, 50:1, 20:1 and 10:1 depending on the size of lots traded.

So Why not Just Choose 10:1 leverage option as the Maximum Leverage for Your Account? Because to keep within the suitable risk management guidelines 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 Forex Trading.

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

This is calculated in real time as you trade - as you open and close trades this free margin is calculated. To keep your borrowed money you must maintain what is known as the required capital (your deposit).

Now if Your Leverage is 100:1

When trading if you have $1,000 and use leverage option 100:1 and buy 1 standard forex lot for $100,000 your margin on this transaction is the $1000 dollars in your account, this is the money that you will lose is your open trade transaction goes against you - the other $99,000 that is borrowed from you broker, they (your broker) will close the open trades automatically once your $1,000 has been taken by market.

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

For 20% Margin requirement before closing your transactions automatically, then your open trades will be closed once your account balance gets to $200

For 50% Margin requirement of this free margin level before closing your open forex positions automatically, then your open trades will be closed once your account balance gets to $500

If your broker set 100% Margin prerequisite of this level before closing out your open trade positions automatically, then your trade will be closed once your account balance gets to $1,000: Meaning the trade that you will open will close out as soon as you execute it because even if you pay 1 pip spread your account balance will get to $990 & the needed Margin requirement percentage level is 100 percent i.e. $1,000, hence your open trade orders will immediately get closed.

Most online brokers do not set 100% Margin requirement, but there are those brokers that set Margin requirement at 100% and these brokers aren't suitable for you at all, choose those brokers that set 50% or 20% margin requirements, in fact, those brokers that set at 20 % are some of the best since due to the likely hood they stop out-out your open trade is reduced as shown in above example.

To know about this margin requirement level which is calculated by your platform automatically - The MetaTrader 4 Software will display this as "Margin Requirement", This will be displayed as a percentage the higher the percentage the less likely your open trades are to get closed.

For Example if

Using 100:1

If leverage ratio is 100:1 & you transact 1 Mini Lot, equals to $10,000

$10,000(mini lot) divide by 100:1, your used funds is $100

Calculation:

= Capital Used * Percentage(100)

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

Margin Requirement = 1,000 %

Trader has 980 percent above requirement amount

Using 10:1

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

$10,000(mini lot) divide by 10:1, your used funds is $1000

Calculation:

= Capital Used * Percentage(100)

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

Margin Requirement = 100%

Investor has 80% above the required sum

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

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

Margin and Free Margin is displayed by the MT4 Software