Leverage and margin
Leverage is the ability to pay only a small amount of the value of the currency as an initial payment to open a trade. It enables you to control larger trade sizes with a smaller initial outlay.
While leverage can increase the potential return on investments, it also has the capability to increase potential losses as well, so it’s imperative that you think carefully about the amount of leverage you want on your trading account.
If the leverage of your account is 500:1, this means you can trade up to 500 times the equivalent amount of base currency you have in your account.
Let’s go through an example of two traders – Trader X and Trader Y – who both have an account balance of $10,000.
Trader X has a leverage of 50:1 and Trader Y has a leverage of 5:1.
Let’s compare the effects on their accounts if they were to both have a 100 pip loss.
Through leverage management, Trader Y only lost $500 of his capital, while Trader X lost $5,000. With a conservative leverage strategy, you have a greater chance of long-term success.
What is margin?
When it comes to trading, the concept of margin is sometimes confused with the fee that a trader owes the broker – which is incorrect. Margin is a ‘good faith’ deposit – the collateral that is held by the broker to hold open a position. This is not a transaction cost, nor is it charged to your account, but serves to ensure that you have sufficient balance in your account relative to the size of your position.
The amount of margin that is required depends on your position size and the instrument that you are trading.
Example: If you have a leverage of 500:1 on your trading account and open a one lot position in AUD/JPY (where one lot equals 100,000 AUD), then your margin requirement is 200 AUD. That means that you must have at least 200 AUD (or the equivalent of that amount in another currency) to open a 100,000 AUD position. If the floating value of your account falls below your margin requirement, we may notify you that we’ll close the position.
Losses can exceed deposits.