Weel now to continue on the next chapter about leverage vs margin.
What is the relationship between margin and leverage? What is the difference between leverage and margin?
Margin is the amount of money that you must deposit in a broker to place an order. And maintain a position in the forex market.
Brokers use margins as collateral to ensure you can cover any losses you might find in your position. In this case leverage vs margin, we use a margin to make leverage.
Leverage increases the trading power available when using a margin account. WIth leverage allows us to trade far greater than the funds we invest in.
This leverage is expressed as the ratio between the money you have and the amount of money you can trade.
Leverage is usually written in X: 1 format
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Leverage and margin explained
Leverage in forex is closely related to the concept of “margin”.
What is the margin? Margin is the amount of money that needs to be in our account at the broker as collateral so that we can trade with leveraged funds.
In the example of 1: 100 leverage, for example, we need a “margin” of 1 dollar to trade 100 dollars.
.If we withdraw or lose 1 dollar for some reason, we cannot trade anymore.
Unlike the leverage written in the form of a ratio, margins are usually written in the form of percentages, for example, 0.5%, 1%, 2%, and so on.
If the maximum leverage is 1: 100, then that means the margin required by the broker is 1%. And so on.
For example, you will open a trade in USD / JPY pairs of 1 standard lot.
If you trade without using margin then the funds you will spend are $ 100,000 in your account.
But if you use a 1% margin requirement, then you only need $ 1000 to open 1 standard lot position.
With a margin requirement of 1%, the leverage becomes 100:1.
The image below gives an example of a leverage ratio depending on margin requirements. Leverage vs margin
How to calculate leverage?
To simplify how to calculate leverage by using the following formula in leverage vs margin.
Leverage Ratio = 1 / Margin Requirement
For example, we calculate leverage with a margin requirement of 2%, then using the formula above will be as follows.
50. = 1 / .02
We can also calculate margin requirements based on leverage using the following formula.
Margin Requirement percentage = 1 / Leverage Ratio
To use the formula to calculate margin requirements with leverage, we take the example of a 100: 1 leverage ratio.
0.01 or 1% = 1 / 100
From that calculation, we make the conclusion that 100: 1 leverage uses a margin requirement of 1% or 0.01.
Leverage and margin refer to the same concept, but with a slightly different perspective.
When a trader opens a position, they use a small portion of funds to open from the value of the actual contract.
In this case, the trader uses leverage, he only needs to use small funds to open a position as the actual contract value.
The fraction part expressed as a percentage is referred to as a Margin Requirement. For example, 1%.
The actual amount required to open a position is referred to as “Required Margin”.
For example trading with a margin requirement of 2% of the contract value of $ 100,000, the size of the position to open this transaction is $ 2000.
$ 2000 is the value of the required margin to open this position.
Because you can trade with a contract size using only $ 2000 of funds, you have used 50: 1 leverage.
By using the formula previously described we can calculate the leverage ratio as follows:
Leverage ratio = 1 /Margin Requirement 50 = 1 / 0.02
From the above calculation, we get a leverage ratio of 50: 1.
If you are still confused with the explanation above may be using the image below will be easier to understand.
Forex margin vs. securities margin
Forex margins vs. securities margins have a different meaning.
The definition of margin on security is money borrowed as part of down payment, the amount of which can reach 50% of the purchase price of a security.
In other words, this refers to purchases on margin.
Thus if you trade in stocks using margin then it means you are borrowing money from broker stocks to buy stocks, basically, this is a loan from a broker.
Meanwhile, the notion of margin in forex is the number of funds that you deposit with the broker as collateral you open a position, it is not a down payment as is the case with stocks.
Margin in forex is amount funds locked as collateral between the seller and the buyer as a good intention to ensure each party to settle the obligations in the agreement.
In the forex, the margin is not a loan, as is the case in stocks.
When trading in forex, this only makes buying and selling using the contract exchange in the agreement, so it doesn’t require borrowing money.
The term margin is widely used in various types of financial trading, understanding the difference between margin in forex and margin in stock trading will provide how this margin works in both types of financial markets.
Leverage and margins are not only in forex, but also in the stock market, futures market, and so on.
However, leverage in markets other than forex is usually very small, only ranging from 1: 2 to 1:20. Only leverage in the forex market can reach 1: 100 or even 1: 1000.
But as a trader also must understand the concept of leverage offered by brokers because the higher the leverage means the margin trading will be smaller and this can trigger over trading which causes the margin level will quickly narrow.
A description of leverage can also be found in the article about what forex leverage is.
Are you ready to start trading?