Leverage allows traders to execute transactions in an amount significantly in excess of their account balance. If you have an account of $100 and the broker offers a leverage of 100:1, you will be able to open a position one hundred times the balance, which in this case is 100 x $100 = $10,000.

The required margin determines the amount of collateral needed to open a position. A margin of 1% means that to buy $10,000, collateral of $100 would be required (10,000 x 1%). The remaining $9,900 will be provided as a loan from the broker.

You can see that the same situation could be presented from different angle. A 1% required margin equals 100:1 leverage, a 5% margin equals 20:1 leverage, a 10% margin equals 10:1 leverage.

Margin is not a commission or fee, but a temporarily“ freezed” amount that is used to secure the loan. When the position is closed, the margin amount is released.

Let’s continue with the example:

We have funded our account with $100 to a broker offering 100:1 leverage. We would like to make a purchase of €1,000 at a EUR/USD rate of 1.1500 (the euro is the base currency). Without leverage, we could purchase approximately €87 (100 / 1.15) with our $100. How much leverage would we need to buy the desired €1,000?

Let’s first convert this amount into the currency of our account – USD. €1,000 equals $1,150 dollars at the current exchange rate. This amount is 11.5 times ($1150 / $100) our account balance. That is, we need a leverage of 11.5 to make our investment idea a reality. Fortunately, the selected broker offers a leverage of 100:1, so we can proceed with the execution of the transaction.

At the same time, some collateral will be required from our funds in the form of a required margin. The broker’s requirement is 1% of the position size or $1150 x 1% = $11.5.

Let’s consider two scenarios of development on our long position in EURUSD. Since we own the euro, we will profit when it appreciates and lose if it depreciates.

  1. EUR/USD rises to 1.2000, i.e., one euro will now be exchanged for 1.20 dollars. This means that when we close our position, we will get $1,200 for €1,000. This represents a profit of $50 (1200-1150). Thanks to this successful trade, our account has increased by 50% to $150. In this case, the leverage has worked in our favor.
  2. EUR/USD drops to 1.1000, i.e., one euro will now be exchanged for 1.10 dollars. This would mean that when we close our position, we will get $1,100 for our €1,000. This represents a loss of $50 (1100-1150). As a result of this losing position, our account has lost 50% of its value, bringing it to $50.

If the quotes from the above example reach 1.0615 (a loss of $88.5 = 1061.5-1150), then our broker will make a margin call – automatically closing the position. This action protects the broker from losses, exceeding client’s capital. The trader’s account will be left with $11.5 – the amount locked as a required margin.

It is clear from these examples that leverage can be both a tailwind and a headwind. Many traders have lost significant part of their funds in minutes.

Leverage terms vary between brokers. In recent years, many regulators have introduced more restrictive rules on the degree of leverage that can be used by retail traders.

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