(Newswire.net — June 27, 2022) — When trading forex, the terms margin and leverage are among the essential concepts with which traders must be familiar. These paramount goals are to allow a forex trader to handle the trading positions most conveniently.
Margin entails a deposit that needs to be placed so that you can open a trade position. On the other hand, leverage allows traders to trade larger position sizes with a more diminutive capital cost.
Read all about what forex leverage and margin are in this article.
What’s a Margin?
Whether you start learning forex trading online or do it the old-fashioned way, you can immediately notice that both concepts go hand in hand when it comes to forex trading.
In layman’s terms, margin encompasses the required sum of money to open a position. How much money the trader would need to open a position depends on the margin rate. The amount of this rate is presented as the percentage of the absolute value of a trade. It can be determined using two key factors: liquidity and the market’s volatility.
The margin’s importance lies in allowing traders to boost their position, meaning both profits and losses are augmented.
For instance, a forex broker suggests a margin rate of 3.3%, and a trader is looking to open a $100,000 position. The trader would have to deposit $3,300 to enter the trade, whereas the broker will fulfill the rest 96.7%. In this case, the leveraged trade is set at 30:1. As the trade size grows, so will the amount of margin.
In a nutshell, margin level is the ratio between available equity and the used margin, expressed as a percentage. In a formula that would be presented as:
Margin level = (available equity / used margin) x 100
What’s Leverage?
At the core of the concept, leverage refers to the ability of the forex trader to control massive quantities with lesser trading funds. For example, let’s say the leverage is 50:1. This means that the forex trader holds a position estimated at $50 with a single $1.
Forex brokers usually offer the most common ratios like 10:1, 50:1, 100:1, 200:1, and 400:1.
Even though leveraged trading may bring huge profits, the fact remains that it can backfire on the forex trader in terms of heightened potential losses. All of this depends on how much leverage is used.
Let’s assume a CAD/USD trade to paint a clearer picture. For a forex trader to sell or buy 100,000 American or Canadian dollars with no leverage, the trader would have to put in the whole sum of 100,000.
Yet, with a 50:1 leverage, the trader can only put in as much as 2,000 of their funds in their currency for opening and running the said CAD 100,000/USD position.
Forex traders use leveraged trading across many financial markets, including commodities, stocks, exchange-traded funds (ETFs), indices, and treasuries. Most often, leveraged stock trading is the preferred choice for investors not looking to pay the total value of the stock beforehand or deem ownership of the investment.
How Do Margin and Leverage Differ?
Although one is meaningless without the other, the concepts of margin and leverage have their differences.
The main one is that leverage shows the overall amount you have, naturally, enabled through taking on a loan from the broker. Conversely, the margin is a simple “entrance ticket” to a position.
Even though both refer to investing, margin trading requires using the collateral in the margin account as an instrument for lending funds from a broker, which will later require the funds to be paid back with interest. In such cases, the borrowed money is collateral, enabling the borrower to participate in trades.
Another crucial thing to remember is that margin creates leverage. In simple terms, if the margin is the first step to entering a trade position, leverage is what gives you the chance to open a bigger one.
Conclusion
The concepts of margin and leverage are among the essential aspects to comprehend when it comes to trading.
Most traders find trading forex on margin or leverage a lucrative strategy. Still, it shouldn’t go without notice that although profits may rise, so can losses. Before utilizing them on the actual trading scene, it’s best to try them out using a demo account with any broker that you feel suits your needs.
Once you get the hang of it and ensure all the boxes are checked for margin, leverage, margin limits, and leverage ratios, you can carry on and trade worry-free.