Discussion Topic: Forex Leverage and Margin
It doesn’t matter if you are a beginner or an experienced forex trader, understanding the concept of Forex Leverage and Forex Margin is extremely important to all of you. Hence we have decided to write an article explaining the concept of Leverage and Margin in Forex Trading, and how you can calculate Forex Leverage and Margin.
What is Forex Leverage? - The Definition & Concept
The Definition of Leverage is simply - “The ability to control a large amount of money using a small amount of your own money and borrowing the rest.”
So in forex trading, the leverage can be thought of as you are borrowing money from your broker to get into a trade that would otherwise require a large amount of fund deposited in your account.
In the stock market, it is called as “trading on margin”, whereas in Forex Trading it is vastly known as leveraged trading.
What is a Forex Margin? - The Definition & Concept
Margin is the amount of money required by the forex broker as a "good faith deposit" to a new trading position in the market. Without providing the margin amount, you would not be able to place a trade and use the leverage.
Basically, the Forex margin amount is what you broker uses to maintain your position and to cover up any potential losses.
Forex Leverage and Margin, both are very closely related and basically, they are two different approaches to calculate the maximum value of trade you can take with your present account balance.
Explaining Forex Leverage
As we know leverage is simply a loan facility provided to you by the broker. But the most exciting part is that you don’t have to pay any interest if you take leverage.
It doesn't matter what sort of trader you are or what type of forex trading account you have. If you have an account and the broker will offer leverage, though the amount of leverage may vary by account type.
The typical benefit of using leverage is that you get the chance to make a considerable amount of money with only a limited amount of capital investment.
The disadvantage of using leverage is that you can also lose a hefty amount of money while trading with leverage. Though it totally depends on how wisely you use it and how strongly you emphasize on your money management.
Though leverage allows you to trade more units than you have in your account, it does not affect the value of a lot. As you know that a standard lot is 100,000 units of currency and a mini-lot is 10,000 units. These values of lots never change no matter how much leverage to get. The reason we named it leverage is because it is much like lifting a very heavy object with a lever and with less effort.
For example, if you have 100:1 leverage, the value of a mini-lot is still roughly $1 a pip but your facility is that you can buy a mini-lot (10,000 units) by investing just 100 units of currency.
The simple formula to calculate leverage is:
If you have a Leverage of - X:1 and you want to buy a mini-lot (10,000 units), then you would need (10,000/X) units of base currency.
Common Forex Leverage Amounts
Leverage is generally offered in a fixed amount and expressed as a ratio. Each broker offers leverage as per their internal as well as country-specific rules and regulations, so the amount can vary significantly depending on broker and country.
For example, US Citizens are allowed to take a maximum leverage of 50:1 for major & minor pairs and 20:1 for exotic pairs.
The Common leverage amounts (global) are typically 20:1, 50:1, 100:1, 200:1 and 400:1.
Twenty to one leverage means you need $1 to place a trade order of $20.
Fifty to one leverage signifies that for every $1 you have in your account you can open a trade worth $50.
As an example, if you deposit $200, you would be able to trade for an amount up to $10,000 on the forex market using 50:1 leverage. It's not recommended to trading the full amount ($10,000) in any situation, but you would have the ability to trade up to that amount.
A leverage of One hundred to one means that for every 1 unit of currency you have in your account, you can place a trade worth 100 units of currency. This is the most common leverage amount offered on a standard lot account.
For example, the typical $2000 minimum deposit for a standard lot account would provide you the power to control $200,000.
Two hundred to one leverage signifies that for every 1 unit of currency you have in your account, you can open a trade worth 200 currency units. This is a common leverage amount offered on a mini and micro lot account.
For example, the typical $100 minimum deposit amount for a micro lot account would give you the facility to place trades up to the amount of $20,000 (2 mini lots or 20 micro lots).
The leverage of Four hundred to one means that for every 1 currency unit you have in your account, you can open a trade worth 400 units of currency. Though this is not very common, some brokers offer 400:1 leverage on mini or micro lot accounts.
For example, anyone depositing $200 into their forex account can place a trade up to $80,000 (we don't recommend it).
Calculating the ROI (Return on Investment - on Leverage)
We would use some example to make you understand how the leverage affects the ROI (return on investment) and how to calculate the effective ROI based on your leverage.
Suppose you broker provides you a leverage of 100:1, So with just $1,000 in the account, you are allowed to control a position of $100,000 ($1000 x 100 = $100,000).
Though it's not recommended to utilize the full amount of fund, still for this example let's assume that you are now controlling $100,000 with $1,000.
Now let’s assume the $100,000 investment rises in value to $101,000, so you profit comes to $101,000 - $100,000 = $1,000.
If you had to put the entire $100,000 capital yourself, that is a leverage of 1:1, your ROI would have been a tiny 1% ($1,000 profit / $100,000 capital investment).
But in case of 100:1 leverage, your broker will only put aside $1,000 of your money and the rest $99,000 would be leveraged by them. Hence your ROI would become smashing 100% ($1,000 profit / $1,000 capital investment).
The earlier example describes the advantage of forex leverage; now let's see the other part of it. Calculating your ROI in case if you lose $1,000 in the trade.
If you calculate it with 1:1 leverage, you would have ended up with just -1% ROI (loss), but with 100:1 leverage this would become a scary -100% ROI (loss).
In your trading career, you’ve most likely heard the phrase “Leverage is a double-edged sword”, now you know that how correct the phrase is.
Explaining Forex Margin
We already know what forex margin is and now we would be learning how the margin affects the forex trading. We would also learn to calculate the maximum amount you can trade using the margin facility provided by your broker.
Now we would be using the previous example which we used in order to explain the leverage.
You get a leverage of 100:1, you have opened a trade of $100,000 and due to the leverage your broker put aside $1,000 from your account.
In this case, the $1,000 deposit is called as “margin” or "margin required” that you had to give in order to use the leverage.
The margin is used by your broker to maintain your position. Basically, your broker takes your margin deposit and pools them with everyone else’s margin deposits. Then by using this “super margin deposit” they place trade orders within the interbank network.
Unlike leverage, the Forex Margin is typically expressed as a percentage of the full amount of the position. For example, most forex brokers say they require 5%, 2%, 1%, 0.5% or 0.25% margin.
Based on the margin required by your forex broker, you can easily calculate the maximum leverage you are allowed to take with your trading account. Margin to leverage conversion (or vice versa) can be done using a simple formula:
Leverage = 100 / (Margin amount)
Margin Amount = 100 / Leverage
So, if your broker is providing you a margin of 0.5% then the maximum leverage you can get is 200:1 (i.e.- 100 / 0.5 = 200).
A table with common margin amount used in forex trading and their equivalent leverage is provided below:
|MARGIN REQUIRED||MAXIMUM LEVERAGE|
In the above section, we have just learned about forex margin, which is also called as “margin required”.
You may see other variation of margin in your trading terminal, so don’t get confused with them. We are defining some of the terms related to margin to help you understand better.
Margin Required: This is what we discussed in this entire article. It is basically the amount of money your broker requires to be present in your account to open a new trade position. It is expressed in percentages.
Account Margin: It is the total amount of money (fund) you have in your trading account.
Used Margin: The amount of money that your broker already puts aside (locked up) to keep your current trade positions open. Although this money is still yours, you can’t touch it until your broker returns it to you, either when you square off your current positions or when you receive a margin call.
Usable Margin: This is the unused money in your account that is available to open new trade positions.
Margin Call: Sorry to say! But you can get this unfortunate margin call when the available amount of money in your account cannot cover your possible loss. It happens when the value of your forex trade falls below your used margin.
Hope you have enjoyed the above article on Forex Leverage and Margin. Be with us to explore forex trading, stocks trading, and other money-making opportunities.
Leave us some comments if you have any questions about Forex Leverage and Forex Margin. Also, let us know what amount of margin you getting from your broker.