What is Leverage?
When you trade the markets, traders generally do so with leverage. Leverage is a loan that the broker provides to the trader. Essentially, the textbook definition of “leverage” can be summarized as having the ability to control a large amount of money using none or very little of your own money and borrowing the rest.
Leverage is expressed as a ratio, and the higher the ratio, the more leverage the trader has. For example, if a broker offers a 50:1 leverage ratio, that means that for every $1 in your account, you can trade up to $50. That is to say, to control a $50,000 position, the broker will set aside $1,000 of your account for that trade.
Think about it this way…
In the 50:1 leverage example above, if you made a $1,000 return on your $50,000 trade, you have made a 100% return on the $1,000 the broker set aside for the position.
If, on the other hand, you had to produce the $50,000 of trading capital yourself, you’d have made a lowly 2% return on your investment.
But trading leveraged positions also has huge implications for losses. Think about potential losses in this example…
If you lost $1,000 on your leveraged $50,000 position, you’d lose your entire account! While on a 1:1 scenario where you had put up the entire $50,000 yourself, you’d have lost 2%.
As you can see, leverage gives traders the ability to make bigger profits than they would be able to with their own capital alone. However, it also magnifies losses. That’s why effective use of margin is essential in trading.
What is Margin?
In our example above, with 50:1 leverage, you are putting up $1,000 to control a position of $50,000. The $1,000 that you put up is called margin.
Margin is a deposit that a trader must make in order to open and maintain a leveraged position. It is designed to ensure that the broker can cover any losses incurred due to the trader’s actions, as well as act as a “good faith” deposit used to secure the position. The amount of margin required depends on the leverage you are trading with and can range from as low as 1% (100:1) to as high as 50% (2:1).
In trading, margin is expressed in terms of a percentage or ratio of the size of the position. The required margin is determined by the broker and varies depending on the leverage ratio offered. For example, with a leverage ratio of 50:1, the required margin would be 2%. The higher the leverage you use, the less margin you need to open a position.
Below, you’ll find a table of common leverage offered by brokers and the corresponding margin requirement:
|MAXIMUM LEVERAGE||MARGIN REQUIREMENT|
Other “margin” related terms you’ll want to know include:
Margin requirement: Margin requirement is the amount of money that you need to have when you want to trade with leverage. It helps the broker cover their losses if you make any mistakes. The higher the leverage, the less money you need for your margin requirement.
Account balance: The total amount of money in your trading account — or your bankroll.
Used margin: Used margin is the amount of money in your trading account that you use to open a leveraged position and to keep your current positions open. You can’t use it unless you close your positions or the broker closes them for you.
Usable margin: This is the money that you have in your trading account that is available to open new positions or keep existing ones open. It is the money left over after you have taken into account the margin requirement.
Margin call: A margin call is what happens when you don’t have enough money in your trading account to cover the losses of a leveraged position — or, in other words, when your equity falls below your used margin. Your broker will let you know that you need to put more money in your account or close the trade.
Disclaimer: All information provided here is intended solely for study purposes related to trading financial markets and does not serve in any way as a specific investment recommendation, business recommendation, investment opportunity, analysis, or similar general recommendation regarding the trading of investment instruments. The content, in its entirety or parts, is the sole opinion of SurgeTrader and is intended for educational purposes only. The historical results and/or track record does not imply that the same progress is replicable and does not guarantee profits or future profitable trading records or any promises whatsoever. Trading in financial markets is a high-risk activity and it is advised not to risk more than one can afford to lose.