Forex for beginners

What is margin and leverage in simple words

Margin
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Many traders have a vague idea about such basic concepts like leverage and margin. Of course, to open or to close the deal, know the meaning of these two terms is not necessary. Over time, however, when a trader begins to delve into the intricacies of Forex trading, it is necessary to understand them.

What is leverage

So what is leverage and margin and how they are interconnected. And let’s start with the first concept — leverage. Every trader when opening an account, chose or accepted the proposed value of leverage. It usually appears in the form of proportions: 1:10, 1:100, 1:500 and so on.

Alpari offers the following range of leverage from 1: 1 to 1:1000. But what do these numbers mean? And they mean the following: how many times greater amount of its trade with the leverage to operate a Forex trader. For example, 1:1 will allow a trader to dispose of only your Deposit amount.

 

And if 1:1000, the trader can enter into transactions for the amount exceeding its Deposit 1,000 times. Is the financial support provided by the broker for its customers so they could trade with their Deposit in Forex. This kind of loan, which automatically gets the trader from the broker.

But, even if the trader lose all their money, the money broker will remain intact. The more leverage, the more trades can open a trader with the same amount of Deposit. And it will depend on margin.

What is margin

Margin is closely associated with leverage. It is a Deposit which is blocked on account of a trader when he opens a trade. If we have two accounts with the same Deposit, but they will be different leverage and we’ll close both accounts are two completely identical transactions, margin funds that will be blocked by the broker to trade will be different.

The more leverage, the less the Deposit, which will freeze the broker on account of the trader. Accordingly, when more leverage a trader can open more trades to get more profit or loss. Therefore I say that high leverage is more dangerous. However, this statement is far from truth, because to be able to risk much and really risky to trade is two big differences.

 

The value of free and blocked margin you can see in the Trade tab (via View -> Terminal) at the bottom of MetaTrader 4. Until a trader has a free margin, they can open transaction including leverage. High leverage gives you the ability to open a large lot, but the professional traders trade, not exceeding the rate of safe the risk no matter what amount they have the opportunity to work.

How interconnected leverage and margin

Now, let’s consider how to calculate margin and leverage affect its size. The leverage ratio shows what part of the transaction amount borne by the trader for their own expense (this is the margin) and what part is covered by the broker. For example, leverage 1:100 means that one hundredth part of the deal the trader pays, and everything else he provides a broker as a loan.

Confirm calculations, however you must remember that for currency pairs where the us dollar (USD) is the main currency (USDJPY, USDCHF), the calculation is performed without the participation of the current course, and for currencies, where the dollar is a secondary currency is also taken into consideration the current exchange rate. Why this is so, read below.

The margin calculation for the USDCHF

Let’s imagine that a trader has a trading account in USD with a leverage of 1:500. This means that when you open the trade the trader will keep the margin of 1 / 500 of its volume, and the remaining funds will be provided by the broker. Open a deal to sell USDCHF currency pair at the value of 1 lot (100,000 units of base currency). Because in USDCHF the base currency is the U.S. dollar, we are selling 100 000 USD.

 

Because the account the trader has opened in dollars, he does not need anything translated using the exchange rate of the pair — sold 1 lot account in USD, margin held also in us dollars:

Margin = Lot / leverage = USD 100,000 / 500 = 200 USD.

That is $ 200 and kept the trader broker during the sale of 1 lot.

If trader has leverage 1:100 then a similar calculation would show that in this case, the margin would have amounted to USD 1 000. With this leverage, the trader could open a transaction 5 times smaller in volume. Now let’s look at how the margin is calculated for those pairs where the us dollar is the base currency.

The margin calculation for EURUSD

Consider for example the currency pair Euro / dollar. Obviously, if we will sell 1 lot of the base currency, then it will not be the us dollar and the Euro. Because the Deposit is in USD, margin will be blocked in the same currency, then the trader will need to learn how you will need US dollars in equivalent. There is useful opening rate of the transaction:

 

On the screenshot you can see that if you sell 1 lot EUR at the price of 1.23398 the trader kept the margin 246.80 USD.

Calculate the margin taking into account the leverage and the exchange rate:

Margin = (Lot × Rate) / leverage = (EUR 100 000 × 1.23398) / 500 = 246.80 USD.

Summing up the above, we can draw some conclusions. First, leverage allows the trader to trade amount bigger than he really is. However, the trader can not lose money to the broker, and only your own. So in the case of losses, the trader will not be something needs to the broker. Second, the more leverage, the more valid the volume of transactions, since an increase in leverage decreases the collateral margin. Third, high leverage does not increase the risk for trade, unless, of course, this will not allow the trader.

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