What is the relationship between margin and leverage?
Margin is a good faith deposit required to keep a trade open.
Leverage is a byproduct of margin and allows an individual to control larger trade sizes.
“Leverage” and “margin” refer to the same concept, just from a slightly different angle. When a trader opens a position, they are required to put up a fraction of that position’s value “in good faith”. In this case, the trader is said to be “leveraged”. The amount that is required to be put up is known as the “Margin Requirement”.
- Assuming a trader chooses to trade one mini lot, 10,000 units, (10K on Trading Station and 0.1 on MetaTrader 4) of the USD/CAD and they have $1,000 USD in equity.
- This trade would be the equivalent to controlling $10,000.
- Now, when you set up an account with FXCM, FXCM will state your maximum Leverage. For most FXCM Markets clients that is 400:1. To go back to the example above, if a trader with leverage of 400:1 wanted to open a mini lot of the USD/CAD (the trade equivalent being a value of $10,000), the trader's required margin to open the trade would be $10,000/400 = $25
In this example, you can see having leverage of 400:1 means your margin requirement will be 0.25% of the value of the trade.
Please note: if your account is not the same currency as the first currency in the pair, you will need to use the exchange rate to determine the trade value.
For example, a trader wants to open a mini lot on 10,000 units, (10K on Trading Station and 0.1 on MetaTrader 4) of EUR/USD. This trade would be the equivalent to controlling 10,000 EUR's, assuming this trader has a USD account. Since the trade is in terms of EUR's, we need to convert the value of the EUR to USD to determine the value of the trade.
FXCM uses fixed margins, meaning we use a fixed exchange rate for margin value determinations. For the EUR/USD, we currently use a fixed exchange rate of $1.60.
So, here is how we calculate margin:
- Calculate the value of 1 mini lot of EUR/USD, = 10,000 * $1.60 or $16,000 USD for a trader with a USD account.
- Now that we have the trade value in terms of USD, $16,000, here is how our leverage and margin works:
With a leverage profile of 400:1, we can take $16,000/400= $40 in margin. Our 400:1 leverage, allows each 1$ to control 400 USD.
With a leverage profile of 400:1, that means your margin is 0.25% of the value of the trade. ($40/$16,000) = 0.25%
Please note: leverage can be a double edge sword. Yes, it can assist a trader in opening a larger trade size than that of their account, but thus amplify gains and losses.