Margin leverage: just at first glance
The fact is that this topic is considered only once, at the very beginning of a person’s acquaintance with the markets, and even then it is extremely superficial. And the most difficult questions for a forex client arise much later when he has already passed the training and tries his hand at a real account. Among the most common questions are the following: «Where can I set a 1:10 leverage?», «How do I know which leverage I am currently investment operations with?», «Why is the 1:2000 leverage considered risky?» etc. Therefore, we sincerely hope that after reading this material, you will find the necessary answers.
First, let’s remember the General definition of margin leverage. So, leverage is the ratio of the funds that a company’s client needs to have on the investment account to open a position and the size of that position itself. For example, the concept of «1:100 leverage» means that if you have 1 conventional unit on your investment account, you can work with 100 conventional units. We’ll look at this in the example below.
In all further explanations, we will use a conditional account for $10,000, with which we will investment operations the USD/JPY currency pair. The standard 1 lot for this pair is 100,000 units of the base currency, in our case, it is $100,000. The table below shows several options for transactions with this margin collateral.
|Amount on investment account||Volume in lots||Volume in currency||Real margin leverage|
|$10.000||10 lots||$1 000.000||1:100|
|$10.000||200 lots||$20 000.000||1:2000|
If you pay attention to the first two transactions, you will see that in the first case (0.01 lot), the margin leverage is not used at all, rather the opposite – we have 10 times more funds than we need. But in the second case, our margin collateral fully corresponds to the volume of the operation, that is, formally, we can work without leverage. At the same time, to make it easier for you to understand, we have introduced a separate term real leverage – this is the ratio of our entire margin collateral to the size of the transaction. However, since we open transactions with the help of a broker, we will not be able to refuse borrowed funds, since the money in our account and the money for which the transaction is opened are completely different categories. Therefore, we will introduce another concept «nominal margin leverage» — this is the figure by which the broker calculates margin requirements. Below is an augmented version of the same table in which we explain the meaning of the most popular leverage 1: 100. Please note that we have removed the last column since it is not possible to open operation for 200 lots with such a shoulder (we will return to this issue later).
|Amount on account||Volume in lots||Volume in currency||Real margin leverage||Margin (Collateral)||Nominal margin leverage|
|$10.000||10 lots||$1 000.000||1:100||$10.000||1:100|
Nominal leverage is the parameter that the broker uses to determine the size of the required margin that you will see in the MT4 terminal (the term collateral is used in the xStation platform). Al Forex clients receive leverage of 1: 100 by default, although, for some instruments (for example, CFDs on stocks), the indicator can change. Moreover, the amount of the collateral does not depend on the amount on the margin security at all. And if, for example, we open a position for 0.1 lot ($10,000), the «margin» column (collateral) will indicate $100 based on the 1:100 leverage. Although we are well aware that with an account size of $10,000, we have enough funds even to cover the entire operation.
And now we can go back to our questions, in particular, to putting up a smaller leverage size. The solution here is that when you read our lessons on money management or plan risks for your transactions, you will be dealing with real margin leverage. That is, you do not need to change any account settings – you just need to open positions that differ from your balance by a certain number of times. As an example, we will take the three most recommended leverage sizes– 1:5, 1:10, 1:20.
|Amount on account||Real leverage||Volume in currency||Volume in lots||Margin (Collateral)|
To find out the real leverage for any open position, simply correlate its size in money with your margin collateral. At the same time, do not bother to recalculate the exchange rate for those pairs where the USD is not in the first place: all the same, the values of the main currencies are approximately the same. Therefore, if you have, for example, a position on EUR/USD with a volume of 0.3 lots (30.000), and on a margin collateral of 1.200 dollars, the real leverage will be equal to 1:25 (30.000/1.200=25).
Above, we promised to tell a little about those cases where dealing centres offer an incredibly high leverage size, thus providing a potentially large profit. Sometimes you can hear about leverage of 1:2000, which is 20 times more than the standard 1:100. To better understand the scheme of leverage, it should be noted that it directly affects the volume of the transaction, and through it – and the cost of one point. That is, the greater the leverage – the greater the value of the item. As a rule, the cost of 1 point is equal to 1/10. 000 of the transaction volume, and if the volume is 0.1 lot or $10,000, the point is equal to 1 dollar (10.000/10.000=1). Therefore, if we work with a lot with a margin collateral of 1.000 (1:10 leverage), the price must pass 1.000 points in our direction so that we double the margin collateral, or 1.000 points not in our direction so that we lose it. If you are familiar with the movements of instruments, you probably know that 1.000 points are the annual movement of most currency pairs, only occasionally the price passes it in two or three months. That is, a complete loss of savings is unlikely.
At the same time, if we work with a margin collateral of $ 1,000 and leverage of 1:2000, the transaction volume will be as much as 2 million! The size of the point will be 2,000,000/10,000=200 dollars. It turns out that only 5 points are not in our direction (and given the spread-and even 3-4 points) can ruin the entire margin collateral! And such a movement is a matter of a few seconds. Therefore, such offers have nothing to do with risk management or long-term work in the markets. By the way, this also applies to the 1:1000 leverage, and even the popular 1:500. In the first case, to reach the Margin Call, we will need to lose only 10 points, in the second-20 points.
To sum up, I would like to say that all the difficulties with choosing the volume of the transaction and the size of the leverage arise only in the first stages of investments. After a while, any person begins to open operations that are safe for their capital without thinking, without bothering with unnecessary calculations. However, at first, it is desirable that you at least mentally calculate all the above parameters to bring this skill to the subconscious level.