Chương 4 The Difference Between Forex Margin and Leverage
Forex margin and leverage are two of the most important aspects required to get started with trading. However, these two terms are often confused by traders.
1. Forex Margin and Leverage
At the most fundamental level, margin is the amount of money in your account that is required as a deposit in order to open and maintain a leveraged trading position.
Leverage simply allows you to control larger positions with a smaller amount of actual trading funds, i.e required margin. In the case of 50:1 leverage (or 2% margin required), for example, $1 in a trading account can control a position worth $50.
These two essential tools allow Forex traders to control trading positions that are substantially greater in size than would be the case without the use of these tools.
Despite these differences, there is a close relationship between the leverage and margin. That is, both go hand in hand.
In simple terms, the margin is used to create leverage. The meaning of leverage is similar to the margin, while margin is expressed in percentage, and leverage is expressed as a ratio.
Leverage is the ratio between the capital you have in your account to the amount of capital you can trade. And this ratio is expressed in the form “X:1,” where X is the amount of leverage.
Therefore, mostly, margin and leverage have an inverse relationship.
2. Calculating the Leverage and Margin
If you wish to purchase one mini lot of a currency, you don’t need $10,000 in your account balance. Instead, you will need only a small percentage of the position size. And this percentage is referred to as margin requirement. This same percentage in terms of a ratio is termed as leverage.
For example, let’s say you want to buy 100,000 units of USD/CAD. If the margin requirement is 1%, you will require only $1,000 to take this trade. That is, the leverage for this trade would be 100:1.
Leverage is calculated using the below formula
Leverage = 1 / Margin Requirement
Considering the above the example, leverage = 1 / 0.01 = 100. Hence, the leverage will be 100:1.
Similarly, if the margin requirement is 2%, the leverage will be 50:1.
Conversely, using leverage, we can obtain the margin requirement as well.
Margin Requirement = 1 / Leverage
For example, if the leverage is 500:1, the margin requirement = 1 / 500 = 0.002
Hence, the margin requirement when leverage is 500:1 will be 0.002 or 0.2%.
