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The Difference Between Margin and Leverage in Forex
The Difference Between Margin and Leverage in Forex.
Are these two concepts even related?
We’ll answer all those questions here!
Margin and Leverage
These concepts are critical because they allow you to take on bigger position sizes.
But, there’s a difference between margin and leverage in forex.
Let’s look at what margin is first…
What’s margin? The difference between margin and leverage in forex
Margin is simply a portion of your account balance that’s required to open a trade.
The margin size is determined by the position size and leverage.
Think of it this way.
Margin is just a down payment to open a forex position. If something goes wrong, you could lose your margin or get a margin call (asking you to top up your margin).
But what isn’t margin?
Margin isn’t a transaction cost.
It shouldn’t be viewed as a fee…
Your margin is returned to your account when you close your open positions…minus any losses/ adding any profits from the trade.
Trading margin accounts
Indeed, you don’t need to put the entire amount of your position when trading forex.
That’s one of forex’s main advantages.
You only need a fraction of it – the margin down payment.
In fact, the margin rate is usually stated as a percentage on your broker’s website.
Let’s consider a forex trading example.
Let’s say you’re looking to buy $100,000 worth of USD/CAD.
You don’t need to put up the total amount when trading forex.
You just have to put up a small amount – the margin.
If the margin percentage is 0.3%, you need to provide $300 on margin.
The benefits of using margin are clear.
But new forex traders tend to get carried away.
New forex traders like to take on lots of massive positions to get rich, quick!
Obviously, this is a mistake and often ends in tears.
Understanding the margin level
Before we talk about leverage, another concept you need to know is margin level.
You might have come across this term.
So what’s the margin level and what does it show?
The margin level is the ratio equity and margin, shown as a percentage.
As your margin level falls to 100%, you can’t place any other forex trades and you’re at risk of getting a margin call. A margin call means that you have to top up your account with more money. If you don’t want a margin call, you must focus on risk and money management.
Remember, when you open a forex trading position, part of your account balance is held as margin. This margin grows with the more positions that you open. At the same time, your free margin falls as a result. If you don’t know, the money that you still have in your account, which you can use to open more trades, is called free margin.
Now that you understand margin, let’s move onto leverage…
Leverage is basically borrowed money to fund an investment.
Indeed, it’s a common concept in business and forex trading.
Forex traders borrow funds from the broker when opening positions. They return this ‘loan’ when the trade is complete and keep all the profits. On the flip side, if the forex trader doesn’t make any money from the trade, he will have the pay back the loan plus any losses.
You’ll find leverage expressed as a ratio.
It may be 30:1 or 50:1 or even 500:1!
Let’s give an example…
You would need to put up $100,000 of your own funds.
That’s a lot of money!
But with 100:1 leverage, you only need to put up $1,000!
This is far more reasonable.
But are there any downsides to using leverage?
The pros and cons of using leverage
Leverage is a double-edged sword and should be handled with care.
On paper, it sounds fantastic…
Over leveraging is one of the common mistakes why retail forex traders blow up accounts.
You can handle bigger positions, and more of them, because of leverage.
But this also means your risk is magnified. Indeed, without solid risk management, it will only take a few pips in the wrong direction to wipe you out completely.
So how much leverage should you use?
We recommended using as much as possible, if you know how to trade forex. But, if you’re still learning how to trade forex, it’s best to be more cautious. We suggest using no more than 50:1 leverage to learn how to trade. That should be enough leverage to get into a few positions, without getting into trouble.
Your ‘Start With Forex’ Takeaway: The difference between margin and leverage in forex
Remember not to separate margin and leverage when thinking about forex.
The concepts are different, but go hand in hand.
Margin is the portion of funds that you need to open a forex trading position. Leverage, on the other hand, is an interest-free loan that the broker gives you to fund your position.
When you close your forex trade, you will ‘pay back’ the leverage and the broker will ‘return’ the margin (minus/plus any losses/gains).
It’s that simple.
Leverage and margin are essential to understand if you want to start trading forex.
Your ‘Start With Forex’ Takeaway: Forex is the easiest way to get into business – and the easiest way to go out of business! (Yes, you can lose money in forex). That’s why you really have to learn how to start trading forex.
If you really want to learn how to trade forex, check out our free forex course here. Alternatively, you can try to use forex signals to learn (i.e. your training wheels), as discussed in this blog post of forex signals.
Remember, there’s a million ways to make a million bucks in the forex markets.
You just need to learn how to trade forex!
To your trading success,
Start With Forex
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