Leverage and Margin Explanation & Examples

Margin required : It's amount of money your broker requires from you to open a trade. It's denoted in %s.

Equity : It's the total sum of capital you have in your trading account.

Used margin : amount of money in your account which has already been used up when buying a trading contract, this contract is the one which is displayed in open positions. As a trader you cannot use this amount of money after opening a trade because you have already used it & it isn't available to you.

In other terms, because your online broker has opened up a trade for you using the capital you have borrowed, you must sustain this usable margin for your trading account as a security to allow you to continue using this leverage he has given you.

Free margin : amount in your account that you can use to execute new transactions. This is amount of money in your trading account which has not yet been trading leveraged because you have not yet opened a trade position with this money - this amount is also very important for you because it enables you to continue holding your open trade transactions as explained & illustrated below.

However, if you over use leverage, this free margin will go below a certain % at which your broker will have to close out all your positions automatically, leaving you with a big loss. broker at this point automatically closes all your open trade position because if your trade positions are left open broker would lose the money you will have borrowed from them.

This is why you should always make sure you have a lot of free margin. To do this as a trader never trade more than 5 % of your account, in fact 2 % is advised.

Difference Between Leverage Set by Broker & Used Leverage

If the set stock leverage is 100: 1, it means you can borrow up to $100 for each $1 you have, but you do not have to borrow all of the $100 for each 1 dollar you have, but you can select to borrow 50:1 or 20:1. In this case even though the leverage ratio option set 100:1 your used leverage will be the 50:1 or 20:1 that you have borrowed to make a trade.

Example:

You have $1000 (Equity)

Set 100:1

Leverage Used = Amount used /Equity

If you buy lots equal to 100,000 dollars that as a trader you will have used

= 100,000/1000

= 100:1

If you buy lots equal to 50,000 dollars that you will have used

= 50,000/1000

= 50:1

If you buy lots equal to 20,000 dollars that you will have used

= 20,000/1000

= 20:1

In these Three cases you can see that though the set is 100:1

Used is 100:1, 50:1, 20:1 depending on size of lots traded.

So Why not Just Select 10:1 option as the Maximum Leverage? Because to keep within the suitable risk management guidelines it is even recommended that traders use less than this?

This question may seem straight forward but it is not, because when you trade you use borrowed equity referred to as Trading Leverage. When you borrow capital from anyone or a bank you must maintain security or collateral to acquire a loan, even if the security is depending on monthly deductions from your own wages, same thing with Indices Trading.

In indices trading the security is known as margin. This is the trading capital which you deposit with your online broker.

This is calculated in realtime as you trade. To keep your borrowed money you must sustain what is known as the required capital (your deposit).

Now if Your Stock Leverage is 100:1

When trading if you have $1,000 and use leverage option 100:1 and buy 1 standard lot for $100,000 your margin on this transaction is $1000 dollars in your account, this is the money which you will lose if your open trade transaction moves against you, the other amount $99,000 that's borrowed, they'll close out the open trade transactions automatically once your $1,000 has been taken by market.

But this is if your online broker has set 0% Indices Margin Requirements before closing out your stock trades automatically.

For 20 % prerequisite before closing out your transactions automatically, then your trades will be closed once your account balance gets to $200

For 50% requisite of this level before closing out your positions automatically, then your trades will be closed out once your trade account balance gets to $500

If they set 100% requisite of this level before stopping out your open positions automatically, then your trade transaction will be closed out once your account balance gets to $1,000: Explanation the trade position will close-out as soon as you open it because even if you pay 1 pips spread your account balance will get to $990 & the needed percentage is 100% i.e. $1,000, hence your trade orders will immediately get stopped out.

Most online brokers do not set 100% requirement, but there are those who set 100% are not suitable for you at all, choose those set 50 % or 20 percent margin requirements, in fact, those brokers that set at 20 % are some of the best because the likelihood they close out your trade position is reduced as displayed in example above.

To know about this level which is calculated by your software automatically - MetaTrader 4 Indices Software will display this as "Indices Margin Requirements", This will be displayed as a percent higher the percent the less likely your transactions are to get stopped out.

For Example if

Using 100:1

If leverage is 100:1 & you trade lots equal to $10,000

$10,000 divide by 100:1, used equity is $100

Calculation:

= Capital Used * %(100)

= $1,000/$100 * %(100)

Indices Margin Requirements = 1000%

Investor has 980 percent above requirement amount

Using 10:1

If leverage is 10:1 & you trade lots equal to $10,000

$10,000 dollars divide by 10:1, used equity is $1000

Calculation:

= Capital Used * %(100)

= $1,000/$1000 * %(100)

Indices Margin Requirement = 100 percent

Investor has 80% above the required sum

Because when a trader has a higher leverage means that they have more % above what is required(A.K.A. More "Free Margin") their open indices transactions are less likely to get closed out. This is reason why traders will choose ratio 100:1 for their account but according to their money management guidelines, these traders will not trade above 5:1.

These Levels are Shown on the Platform Screenshot Below as an Example:

MetaTrader 4 Stock Software