Margin & Leverage Explained

When we are trading, we take ownership of something that has value. If you take a trading position in a currency, that position has the potential to make you or lose you money. Therefore, it is fair to say that your trading position has value. You want the value to increase to make a profit. That is the simplest truth of trading and speculation.​

The Purpose of the Broker

The broker you trade with is the connection between you and the financial markets. It is just like a supermarket where you buy your food. The supermarket acts as the broker between you and the food producer. When you take a position in, say, a currency pair, you take possession of something that has value.

We can illustrate this with a simple example:​

• EUR/USD trades at 1.0550. You decide to buy it.
• EUR/USD later trades at 1.0580.
• Your “investment” in Euro-Dollar has increased in value.

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Owning without paying
Unlike a supermarket, where you have to pay for what you buy, a financial broker—like the ones you find on TraderGuide—will allow you to take possession of “the goods” without paying for them upfront.

Instead of owning the asset, such as Euro-Dollar, you simply borrow it until you decide to close the position. The broker will not ask you to pay the full value of, say, Euro-Dollar. Instead, they will ask you for a “deposit.” This is what we call margin.​

What is Margin?

Margin is the amount of money you have to deposit with the broker to take possession of the asset you are trading. This is usually expressed as a percentage of the value of the “asset” you are trading.​

Example
You buy EUR/USD at 1.0550. The value of your investment is $1.0550, or in words, “one dollar and five and a half cents.”

​Practical example
Say you buy a “one-lot” position in Euro-Dollar. A “one-lot” position means that you risk $1 for every point Euro-Dollar moves.
If Euro-Dollar moves from 1.0550 to 1.0551, your asset has increased in value by one “pip” or one “point,” and you have made one dollar.
The value of your asset when you bought it was: 1.0550 × 10,000 = $10,550. So, the value of your position is actually $10,550.​

Broker margin
Your broker will not ask you for $10,550. Instead, the broker will ask you for a percentage of $10,550. What that percentage is will be discussed in a moment. For now, all you need to know is that when we trade with FX and CFD brokers, you are trading on margin, which means that:

• You never pay the full value of the asset you are trading.
• Instead, you place a “deposit,” which is called your margin deposit.

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What is Leverage?

Margin and leverage go hand in hand. Now that we know “margin” is the deposit we pay to control, say, Euro-Dollar, the question is: How much do we pay to control Euro-Dollar?
That’s where leverage comes in.​​

Example
In the example above, we take a position in Euro-Dollar worth $10,550. If the broker asks us for 10% margin, it means we will have to deposit: $10,550 ÷ 10 (10%) = $1,055.​

High leverage
If the broker asks you for a 10% deposit, we would say you are trading on “ten times leverage.” The fact is that no broker will ever ask you for a 10% margin. Most brokers you find on TraderGuide will offer leverage between 30 times and 500 times.
What would that look like?

• 30 times leverage: $10,550 ÷ 30 = $351.67
• 500 times leverage: $10,550 ÷ 500 = $21.10

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What does this mean?
As you can see, trading Euro-Dollar in the example above, using 30 times leverage, means the broker will ask you for $351.67 to be available in your account. This money will now be frozen in your account, meaning you can’t use it for anything else while you hold this position. If your broker offers you 500 times leverage, you only need $21.10 in your account to control a $10,550 position in Euro-Dollar.​

Is high leverage dangerous?
Yes. If you don’t know what you are doing, controlling a large position with little “margin” means your trading position can make you or lose you a lot of money very quickly compared to what you had to pay in “margin” to control the position.​

Please explain why
Imagine you have a $100 trading account, and you buy Euro-Dollar as above, depositing only $21.10 in margin because you are trading with a broker offering 500 times leverage. What happens if Euro-Dollar rises after you buy it?​

Example
EUR/USD rises from 1.0550 to 1.0560.

• Now you have 10 pips, with each pip worth $1.
• You just made $10, increasing your trading account by 10% from $100 to $110, all while depositing just $21.10 in collateral.

This is the beauty of margin trading. You can control financial assets by putting down just a fraction of their value as margin.​

The flip side
However, as quickly as you can make money, you can lose it. If Euro-Dollar fell from 1.0550 to 1.0540, you would lose $10—or 10% of your account.​

Final Thoughts

There is nothing wrong with trading with a high-leverage broker. Most brokers we recommend offer 200 times leverage. However, we strongly advise treating leverage with great respect. Leverage can be a powerful tool for wealth creation, but it can also destroy your account if you do not use money management tools, such as a stop-loss.