“Leverage” and “margin” refer to the same concept, just from a slightly different angle.
A trader uses margin to trade with leverage. A margin account allows you to have increased buying power. Leverage lets you trade bigger positions than the amount of cash in your account. Leverage and margin have an inverse relationship — the higher the margin requirement, the lower your leverage ratio will be.
You use margin to create leverage.
Leverage is the increased “trading power” that is available when using a margin account. Leverage allows you to trade positions LARGER than the amount of money in your trading account. Leverage is expressed as a ratio.Leverage is the ratio between the amount of money you really have and the amount of money you can trade. It is usually expressed with an “X:1” format.For example, if you wanted to trade 1 standard lot of USD/JPY without margin, you would need $100,000 in your account. But with a Margin Requirement of just 1%, you would only have to deposit $1,000 in your account. The leverage provided for this trade would be 100:1.
Here are examples of Leverage Ratios depending on the Margin Requirement:
How to calculate Leverage:
Leverage = 1 / Margin RequirementMargin Requirement is 2%
50 = 1 / .02The leverage is 50, which is expressed as a ratio, 50:1
Margin Requirement = 1 / Leverage RatioLeverage Ratio is 100:1
0.01 = 1 / 100The Margin Requirement is 0.01 or 1%.
When a trader opens a position, they are required to put up a fraction of that position’s value “in good faith”. In this case, the trader is said to be “leveraged”. The “fraction” part which is expressed in percentage terms is known as the “Margin Requirement”. For example, 2%. The actual amount that is required to be put up is known as the “Required Margin”.
2% of a $100,000 position size would be $2,000. The $2,000 is the Required Margin to open this specific position. Since you are able to trade a $100,000 position size with just $2,000, your leverage ratio is 50:1.
Leverage = 1 /Margin Requirement
50 = 1 / 0.02
- Leverage, which is the use of borrowed money to invest, is very common in forex trading.
- By borrowing money from a broker, investors can trade larger positions in a currency.
- However, leverage is a double-edged sword, meaning it can also magnify losses.
- Many brokers require a percentage of a trade to be held in cash as collateral, and that requirement can be higher for certain currencies.
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