Leverage and margin in Forex
There are two similar contexts that are used in Forex and these are the margin and leverage in trading.
The margin, quite simply put, is the amounts of money required to begin or open a position and to keep it open. The used margin is the amount of you that is used when keeping an open position, and the amounts that is free is available to be used to open a new position. On trades where there is a 1% margin, this would allow you 100 times the initial margin amounts. This means if you have a balance of one dollar you can trade to the value of $100. This is your margin, and if you have traded $100 then your one dollar margin is used and you can no longer trade higher than $100 nor can you begin a new trade as you have no free margin left.
Should you by way of trade, exceed your margin balance ($100), you cannot longer keep an open position, that sees you can buy no more, and you will receive a margin call, which is the term that is used to require you to add funds to your account to continue trading, or close your open position. This is sometimes done automatically by the broker, and would depend on your representative and previous trades. The amount that would be required to continue an open position can be negotiated by prior agreement or at broker discretion depending on your qualities as a trader as well as your calls.
This may seem very similar to leverage, but has subtle difference. We leverage you can force your trading to a high level without having a margin call, after using all of your used margin. The margin itself is leverage, to the effect of 100 to 1, and so using leverage you can open a higher position than $100 and the ratio of your position (your total currency position) to the value of your margin (your margin amounts), you can trade to a much high level with fewer funds.
So why don’t we all use leverage?
Quite simply put, leverage is trading on borrowed funds, and the rewards from trading high by making profits on small pips, would be that much greater if you made 10,000 trades as opposed to 100, and by the same reasoning the losses would be the same. Unfortunately, it is not free money, and all losses have to be repaid. Over leverage will not only wipeouts your margin, it can also leave you to reimburse leverage amounts.
Often the largest and most devastating trader wipeouts are from the over-leaverage usage in trading ( and the disguise of previous loses!)
Take care!
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Thanks for the post, it definately answered some of my questions.
How long have you been trading?
When I started learning about the Forex market, I was amazed about the concept of leverage. Leverage is technically a loan that is provided by the Forex broker or financial institution that is handling the clients account. This “loan” allows a trader to invest more money than they have in their account, thus either significantly increasing their profits or if the market turns against them, decreasing their profits.