What’s the connection between Margin and Leverage?
Margin is used to build leverage.
The additional “trading power” available when using a margin account is referred to as leverage.
You can use leverage to trade positions that are larger than the amount of money in your trading account.
Leverage is measured as a ratio.
The relationship between the amount of money you actually have and the amount of money you can trade is known as leverage.
It is typically stated in the “X:1” format.
To trade one normal lot of USD/JPY without margin, for example, you would need $100,000 in your account.
However, with a 1% Margin Requirement, you would simply need to deposit $1,000 in your account.
The leverage available for this trade is 100:1.
Here are some examples of leverage ratios based on the required margin:
|Currency Pair||Margin Requirement||Leverage Ratio|
Here’s how to calculate Leverage:
Leverage = 1 / Margin Requirement
For example, if the Margin Requirement is 2%, here’s how to calculate leverage:
50 = 1 / .02
The leverage is 50, which is expressed as a ratio, 50:1
Here’s how to calculate the Margin Requirement based on the Leverage Ratio:
Margin Requirement = 1 / Leverage Ratio
For example, if the Leverage Ratio is 100:1, here’s how to calculate the Margin Requirement.
0.01 = 1 / 100
The required margin is 0.01 or 1%.
As you can see, leverage is inversely related to margin.
The terms “leverage” and “margin” refer to the same concept, albeit from significantly different perspectives. When a trader opens a position, they must put up a percentage of the position’s value “in good faith.” The trader is said to be “leveraged” in this instance.
The “fraction” part, given in percentage terms, is referred to as the “Margin Requirement.” For instance, 2%.
The actual amount that must be put up is referred to as the “Required Margin.”
For instance, 2% of a $100,000 position size equals $2,000.
The required margin to open this position is $2,000.00.
Since you are able to trade a $100,000 position size with just $2,000, your leverage ratio is 50:1.
Leverage = 1 /Margin Requirement 50 = 1 / 0.02
Forex Margin vs. Securities Margin
Forex margin and securities margin are not the same thing. It is critical to understand the distinction.
Margin is the money you borrow as a partial down payment, usually up to 50% of the purchase price, to buy and own a stock, bond, or ETF in the securities market. This is commonly referred to as “buying on margin.”
So, if you trade stocks on margin, you are borrowing money from your stockbroker to buy stock. Essentially, it is a borrowing from the brokerage firm.
Margin is the amount of money that you must deposit and keep on hand with your trading platform when you initiate a position in the forex market.
You do not own the underlying currency pair, and it is not a down payment. Margin can be thought of as a good faith deposit or collateral used to ensure that each party (buyer and seller) can meet their contractual obligations.
Margin in forex trading, unlike margin in stock trading, is not borrowed money. Nothing is actually bought or sold while trading forex; simply the agreement (or contract) to buy or sell is traded, therefore borrowing is not required. The term “margin” is used in a variety of financial markets. There is, however, a distinction between how margin is employed when trading equities and when trading FX. Understanding this distinction is critical before beginning to trade forex.
Next Lesson: How to Avoid a Margin Call