What are Leverage & Margin in Trading?
Leverage allows a trader to control a larger position using less money (margin) and therefore greatly amplifies both profits and losses. Leveraged trading is also called margin trading.
Leverage will amplify potential profits and losses. For example, buying the EUR/USD at 1.0000 with no leverage, to take a total loss the price must go to zero, or to 2.0000 to double your investment. If you trade using the full 100:1 leverage, a price movement of 100 times less will produce the same profit or loss.
Margin is the capital a trader must put up to open a new position. It is not a fee or cost and is freed up again once the trade is closed. Its purpose is to protect the broker from losses. When losses cause a trader's margin to fall below a pre-defined stop out percentage, one, or all open positions, are automatically closed by the broker. A margin call warning from the broker may or may not precede such liquidation.
How Does Leverage Work
With 100:1 leverage a trader can open a position 100 times greater than they could without leverage. For example, if the cost to open a trading position of 0.01 lots of EUR/USD is $1,000 without leverage, and a broker offers 100:1 leverage, then a trader must use only $10 as margin. Of course, traders can also use little leverage, like 30:1 or 5:1, or no leverage at all.
Caution: Higher leverage ratios means higher risks. Most professional traders use a low leverage ratios, up to 5:1, or none at all, and a modest risk percentage per trade (2%).