M
argin is the amount of money required to open a position, while leverage is the multiple of exposure to account equity.
The amount of margin depends on the margin rate requirements.
Simply put, you need to have only a fraction of the funds in order to open a much larger position.
This means rather than paying the full value of the position, you only need to pay a percentage of the position, which is called ‘initial margin’.
You use margin to create leverage.
Leverage gives you exactly this power to trade positions LARGER than the amount of money in your trading account.
Leverage is expressed as a 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.
Take for an example that you want to trade 1 standard lot of USD/CHF 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.
Look at some examples of Leverage Ratios depending on the Margin Requirement:
Leverage can be represented like this:
Let’s take for instance that your Margin Requirement is 2%, here’s the formula:
50 = 1 / .02
The leverage is 50, which is expressed as a ratio, 50:1
The Margin Requirement based on the Leverage Ratio will look like this:
Let’s say that the Leverage Ratio is 100:1, so the Margin Requirement will be calculated:
0.01 = 1 / 100
The Margin Requirement is 0.01 or 1%.
Leverage has a very tight relationship to margin.
We will repeat it once again, because you need to fully understand how it works. It will be critical to see it clearly prior to your trading.
If you want to open a position, you will be asked by your broker to put up a fraction of that position’s value as a collateral. In this case, it means that you will be “leveraged”.
This “fraction” part which is expressed in percentage terms is the “Margin Requirement”. For example, 2%.
The actual amount that you will be asked to deposit is known as the “Required Margin”.
For example, 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.
50 = 1 / 0.02
Forex Margin vs. Securities Margin
There is a HUGE difference between Forex margin and securities.
Don’t get confused that you can think of Forex margin as securities in stock market.
If you are trading stocks, margin will be this amount of money you borrow from your stock broker as a partial down payment, usually up to 50% of the purchase price, to buy and own a stock, bond, or ETF.
It is referred to as “buying on margin”.
This is some kind of a loan from the brokerage house.
Oppose to that, in the forex market, margin is the amount of money that you must deposit as collateral in order to open a position.
It is NOT a DOWN PAYMENT or borrowed money, it is just good faith deposit that ensures your broker that you meet their obligations of the agreement.
Remember that in forex market when you are trading currency, you do NOT own the underlying currency pair.
It is only the agreement (or contract) to buy or sell are exchanged, so borrowing is not needed.
The term “margin” is used across multiple financial markets.
But understanding the difference of how and when “margin” is used in every market is crucial to your trading.
