Forex Leverage & Margin

Concept of Leverage explained

It is important for inexperienced traders and clients who are new to trading FX, or indeed new to trading on any financial markets, to completely understand the concepts of leverage and margin. Too often new traders are impatient to begin trading and fail to grasp the importance and impact these two critical success factors will have on the outcome of their potential success.

Leverage, as the term suggests, offers up the opportunity for traders to lever up the use of the actual money they have in their account and risked in the market, in order to potentially maximize any profit. In simple terms; if a trader uses leverage of 1:100 then every dollar they are actually committing to risk defectively controls 100 dollars in the market place. Investors and traders therefore use the concept of leverage to potentially increase their profits on any particular trade, or investment.

In FX trading, the leverage on offer is generally the highest available in the financial markets. Leverage levels are set by the forex broker and can vary, from: 1:1, 1:50, 1:100, or even higher. Brokers will allow traders to adjust leverage up or down, but will set limits. For example, at RFOREX our maximum leverage (on our ECN standard account) is 1:500, but clients are free to select a lower leverage level.

What is Margin?

Margin is best understood as a good faith deposit on behalf of a trader, a trader puts up collateral in terms of credit in their account, in order to hold open a position (or positions) in the market place, this is a requirement because most FX brokers do not offer credit.

When trading with margin and using leverage, the amount of margin required to hold open a position or positions is determined by the trade size. As trade size increases margin requirements increase. Simply put; margin is the amount required to hold the trade or trades open. Leverage is the multiple of exposure to account equity.

What is a margin call?

We have now explained that margin is the amount of account balance required in order to hold the trade open and we have explained that leverage is the multiple of exposure versus account equity. So let's use an example to explain how margin works and how a margin call might occur.

If a trader has an account with a value of £10,000 in it, but wants to buy 1 lot (a 100,000 contract) of EUR/GBP, they would need to put up £850 of margin in an account leaving £9,150 in usable margin (or free margin), this is based on one euro buying approx. 0.85 of a pound sterling. A broker needs to ensure that the trade or trades the trader is taking in the market place, are covered by the balance in their account. Margin could be regarded as a safety net, for both traders and brokers.

Traders should monitor the level of margin (balance) in their account at all times because they may be in profitable trades, or convinced that the position they are in will become profitable, but find their trade or trades are closed if their margin requirement is breached. If the margin drops below the required levels, RFOREX may initiate what is known as a "margin call". In this scenario, RFOREX will either advise the trader to deposit additional funds into their forex account, or close out some (or all) of the positions in order to limit the loss, to both trader and broker.

Creating trading plans, whilst ensuring trader discipline is always maintained, should determine the effective use of leverage and margin. A thorough, detailed, forex trading strategy, underpinned by a concrete trading plan, is one of the cornerstones of trading success. Combined with prudent use of trading stops and take profit limit orders, added to effective money management should encourage the successful use of leverage and margin, potentially allowing traders to flourish.

In summary, a situation where a margin call might occur is due to use of excessive use of leverage, with inadequate capital, whilst holding on to losing trades for too long, when they should be closed.

Finally, there are other ways to limit margin calls and by far the most effective is to trade by using stops. By using stops on each and every trade, your margin requirement is immediately re-calculated.

At RFOREX, depending on the ECN account selected, clients can choose their required leverage, from 1:1 all the way up to 1:500. Clients looking to change their leverage levels can do so by submitting a request through their trader hub area or by email to: [email protected]

Leverage may increase your profits, but as well can magnify your losses. Please ensure that you understand the mechanics of leverage. Seek independent advice if necessary.

 

Legal: RForex Ltd abide all rules & regulations of international business company, under the company act of Saint vicent & Grenadines. Company provides trading services activities and brokerage, training, managed account services in currencies, commodities, indexes, CFDs and leveraged financial instruments.

Risk Warning: Trading leveraged products such as Forex and CFDs may not be suitable for all investors as they carry a high degree of risk to your capital. Trading such products is risky and you may lose all of your investment. Please read the full Risk Disclosure.