Understanding Leverage and Margin
Learning Some Very Important Terms in Trading, It is a Must before
starting any trade. Leverage, Margin, Balance, Equity, Free Margin,
Margin Call and Stop out Level
Many online traders who trade currencies, commodities and indices etc, do
not know what margin, leverage, balance, equity, free margin and margin
level are, how to manage them, and knowing how to calculate the size of
Margin and leverage are two important terms that are usually hard for many traders to understand. In order to understand what margin is in trading, first we have to know the leverage.
What Is Leverage?
"Leverage" is a feature offered by the brokers.
It is like a special offer indeed. It helps the traders to trade the larger amounts of securities through having a smaller account balance.
For example, when your account leverage is 100:1, you can buy $100 by paying $1.
Therefore, to buy $100,000 (one lot), you should pay only $1000. This is an example to understand what leverage means.
If you are trading at 10 lots USD through an account that its leverage is 50:1, you have to pay $20,000 to buy 10 lots or $1,000,000 USD:
$1,000,000 / 50 = $20,000
This is all about Leverage, it is always important to choose lower leverage with big amount of capital for proper money management trading. The example above shows 20% of leverage.
Margin is calculated based on the leverage.
"Required Margin" is the amount of the money that gets involved in a position or trade as collateral.
When trading commodities (like Crude oil) it is imperative to understand what is it you are buying or selling. Crude oil as a commodity is measured in its own unit.
For example, crude oil is traded in barrels. If you are buying 100 barrels of crude oil at $65.20 per barrel, without any leverage it would cost us $6520 at its current price (100 X $65.20). Remember commodities are quoted in US dollar.
But with the use of leverage you do not need that amount of cash in your balance to open a position of this size.
The broker will lend you the money for such position and just put down a margin requirement.
For instance, the leverage for crude oil is 100:1. This is the same as saying the margin requirement is 1% i.e. you only have to put down 1% of the position size and the broker will lend you the cash to open this position.
Therefore, for a position of 100 barrels of crude oil that costs $6520, the margin requirement is $65.20 (1% of $6520). This is all you would need in an account to open this position.