What is Leverage and Margin

What is Leverage?

Both spread betting and CFDs, regardless of the asset class being traded, allow us to trade with leverage. When trading with leverage you are effectively controlling a position size that is relatively large compared to the size of your deposit.

Traditionally, when you buy an asset you buy at the full purchase price, whether the asset is a currency, commodity or an equity. When trading with leverage you are only paying a fraction of the value of the position, with brokers essentially lending you the rest of the purchase price. This has the benefit that any profit made on the trade is based on the full position size, which amplifies the profits made in comparison to the initial trade deposit.

We also need to remember that the converse is true in the event the trade going against us. Brokers leverage is set individually for each of the products offered for trading. The leverage for a product can be identified in the MT4 platform by right clicking on the relevant symbol in the product list and then clicking on specification, which lists all the specifications for the product including the margin requirements.

The leverage employed is directly related to margin requirements, e.g. a margin requirement of 1% denotes a leverage of 100:1, while a margin requirement of 5% denotes a leverage of 20:1 and so on.

Another important aspect that traders need to understand is that as trading with leverage is effectively trading with money borrowed from GKFX, you may be subject to a small charge when holding positions overnight. Leverage is a powerful tool, when used appropriately it can increase your profits, however if used irresponsibly it can accelerate your losses.

For this reason, experienced traders always look to trade with a stop loss in place and size their position such that if the stop is hit then the amount lost equates to a small percentage of their trading account, typically one percent. It is possible to lose more money than you have in your account, which is why risk management is of critical importance.

All about Margin

Margin is the amount of money that you need in your account to keep a position open. Initial margin is the initial amount required to open a position, this is also called a deposit. If a position moves against you and the net value of the position drops below the margin requirement for the instrument traded, then you may be required to provide an additional margin. This is known as the margin maintenance.

The total equity of your account is calculated as the sum-total of the funds in your account plus or minus your profits and losses. If the total equity in your account falls below the margin requirements, then you may get what is known as a “margin call”. If this unfortunately does happen, then you can do one of two things.

Your first option would be to deposit additional funds in your account so that your total equity increases to a level greater than the margin requirement. Your other option, especially if you have multiple positions or order tickets open, is to selectively close some of them, so that your account meets the margin requirements.

However, if you do not act on a margin call and/or your positions do not rapidly move in your favour then Brokers may automatically start closing your positions on your behalf.

Positions are usually automatically closed in certain situations, such as:

― When your total equity drops below a certain threshold of your margin requirements

― You remain on margin call beyond a threshold period

― Your margin call is during market events which may result in increased volatility

― You are on margin call at the end of the weekly trading period. You should remember that you are liable for the losses incurred on any positions that are closed out, whether automatically or otherwise, even if such losses exceed the total equity/value of your account. It is important to note that margin requirements may vary from time.

It is your responsibility to understand the margin required for your open trades and make sure that you have sufficient funds in your account.

To avoid receiving a margin call it is of paramount importance to have a robust risk management plan in place, this would incorporate a technically valid stop loss, position sizing relative to your account, and rules around limiting your total exposure to a predetermined percentage of your account, typically one percent. It is equally critical to monitor your accounts to ensure that you have sufficient funds to adequately cover the margin requirements of your open positions.

Most brokers have a margin calculation tool that you may use to calculate the margin requirements for your positions. It would be good trading practice to use this tool, not just calculate your initial margin requirements, but to recalculate your margin requirements when a position moves against you, and take the necessary actions as required.