4. Introduction to Margin and Leverage06 October, 2017 by Aayush Jindal in Learn Forex
What is margin?
Margin, in forex trading is one the most important concepts that a trader needs to understand. It is often misunderstood, and many feel that it is a fee charged by brokerage companies.
It’s not a fee, it’s a very small percentage of your deposit kept as security to hold open positions in your account. It largely depends on your open positions: if opened trades are of higher size, your margin requirement may increase.
Margin can also be considered as a small sum kept aside as a collateral to support your open positions.
If the margin percentage required is 2% and you want to open a position of $100,000, then you need to have at least $2000 in your trading account. Similarly, if its 0.25%, you need only $250 in order to trade with $100,000 worth.
This is what makes Forex market one of the most popular markets in the world, as it enables traders to maximize their return on investment.
Important margin related terms
There are four terms we need to understand about the margin: margin required, account margin, used margin and usable margin.
- Margin required is what we have learnt so far, i.e. a small sum required as an insurance to support your open positions.
- Account margin is the total sum available in your trading account.
- Used margin is the amount already locked in as security to support your open positions.
- Usable margin is the remaining amount available for you to open new positions in your trading account.
To sum it up, margin is the main feature in forex trading, and it is always advisable to keep a track of your margins in order to efficiently manage funds and trades.
What is leverage?
If you are new to the forex market, you may come across a term leverage. It is actually a byproduct of margin, and based on the margin required, you can easily find out the max leverage you can have with your trading account.
In general, the term leverage means borrowed funds. While trading currencies your forex broker provides a loan in order to trade with funds larger than your deposit.
In simple terms, you get to trade with more money than your capital and maximize returns. Leverage is always expressed as a ratio, 50:1, 100:1, 200:1, 400:1 and 500:1. For example, if your leverage is 200:1, your required margin is 0.50%. The table below highlights other leverages and margin required.
How leverage works?
If you’re leverage is 200:1 and you have $500 in your trading account, it means you can open trades worth $100,000 ($500 x 200). Similarly, if you’re leverage is 500:1 and you have $500 in your trading account, you can open trades worth $250,000 ($500 x 500). Leverage gives you power and space so that with only $500 as capital, you can earn profits on the equivalent of $250,000.
(This scenario does not consider any profits made in your account and ignores any commission or swap interest)
You have $1000 in your trading account and your selected leverage is 200:1, you opened a EUR/USD buy trade of 1 lot ($100,000) at 1.2500. The EUR/USD pair rates moved higher and you closed the trade at 1.2550.
This means there was a gain of 50 pips, and you made a profit of $500 (each pip value for this example is $10). Because of the leverage, you had a chance to make $500 with only $1000 as initial equity.
Now, for the same example, if your leverage is 25:1, you won’t be able to open a position of the same size (with 25:1, max position can be 25*$1000 = $25,000), and potential profits would be 1/4th of $500.
Higher leverage helps in opening larger positions, and escalates chances of gaining more.
On the other hand, traders must remember that the risk of losing also widens with increasing leverage, higher leverage magnifies both gains and losses. If you get a chance to gain more with higher leverage, there is also a risk of greater loss, having a higher leverage makes the return more volatile.
Leverage and margin are the most powerful tools in the Forex market, boosting account for investors and traders. The best thing is you don’t have to pay any interest on the leveraged amount provided by the broker. In some cases, you can even gain interest in swaps for currencies with higher interest rates.
What leverage does Titan FX offer?
Titan FX offers a high leverage available on all currency pairs, from 1:1 up to 500:1.