How to Calculate Margin and Leverage Wisely?
In this article
Leverage is a mystery in Forex trading. What exactly is leverage in forex, and how to calculate it wisely? Leverage allows a trader to take a loan from your broker. It allows the trader to use a fraction of the money and trade in higher volume.
What is the highest leverage limit in the forex market?
This is the slightest change in the currency price. These movements are carried out in large amounts permitting these tiny price movements into significant profits.
Look into the following scenario below!
If you have $1000 in your account, you can trade up to $100,000. Why is that? The general perception is that leverage is a function of threat. If the account is perfectly manageable, so would be the risk. The ability to enter and exit the trade is much easier than in other markets.
What is the primary purpose of margin accounts?
The margin accounts are generally used to generate leverage by professional traders in the forex market or securities if we talk about the margin accounts.
But the beginner traders should be warned against leveraging basic strategies without a concrete understanding of how the market is moving. Sometimes, they risk losses more than they have witnessed if the investments are not adequately leveraged.
This concept is closely connected, and sometimes it is not easy to differentiate between leverage and margin. Both leverage and margin are different in terms of context and manner of application. The context of an application can be how they are traded and utilised.
Why is there a need to authorise the leverage?
Why is that? This is where the double-edged sword comes in. Real leverage has the propensity to amplify profits or losses to the same extent.
What would the trader do? No real solution is available to the trader. But this is not essentially linked to margin-based leverage. However, it can influence if the trader is not cautious.
But once you have the understanding to manage leverage, don’t be afraid of the leverage. Leverage can be appropriately used with proper management. How to calculate margin and leverage wisely helps the trader to avoid a higher loss of capital.
It would help if you learned how to handle it efficiently. For instance, a smaller amount of real leverage employed to each trade affords better breathing space for the trader.
Can a high leverage ratio impact your forex account?
A high amount of leverage can seriously impact the account.
Let’s take an example; in an era of high unemployment, you are tempted to buy in substantial lot sizes. But what if the leverage trading quickly depletes the trader’s account?
This is a real-life scenario that traders have to accept responsibility. Bear in mind that leverage is supple and customisable with the needs of a trader.
When you borrow a certain amount of money to invest in Forex trading, it offers high leverage. The sense is that a trader can build up and control a considerable amount of money for an initial margin.
How to calculate the amount of margin used?
To calculate the total margin used, you have to multiply the trade size by margin percentage. Then, subtract the margin used for all trades from the remaining equity in your trading account, yielding the margin amount you might have left behind.
For calculating the margin of any given trade, the following formula is used:
Margin Requirement = Current Price × Units Traded × Margin
How to calculate leverage in a trade?
Managing risk per trade is known to be the combination of setting stop and limit orders and applying the leverage. To make the whole leverage calculation easier for you, here is the formula explained for you.
What is the main difference between margin trading and leverage?
Apart from differentiating in the application and context usage, other factors differentiate leverage and margin trading from one another.
Leverage can indicate the buying power level, which is generally afforded by taking a debt.
We all know that both leverage and margin practices involve borrowing. But margin trading involves the usage of collateral that is present within your trading account. Thus, it acts as a medium of borrowing money from any broker, which you need to pay back with interest.
Major rules to apply when selecting leverage for trading
Some accepted rules do apply when selecting leverage.
- Minimum leverage should be chosen.
- To safeguard the capital and reduce downside, put trailing stops
- Finally, limit the capital usage to 1% or 2% on each position
The greater the leverage, the lower will be the margin requirements. A real-life example is the currency pairing with British pounds and Japanese yen. The exchange rate can fluctuate extensively, causing large swipes in the rate.
What strategy to use if the currency movement is volatile?
If the currency movement is more volatile and if the volatility of the currency is higher, then the use of stop-loss order is one of the strategies forex brokers use to avoid losses.
Most traders do not exhaust their entire account as margin for each trade; the real leverage tends to differ from margin-based leverage. For example, you have $10,000 in your account; you open a $100,000 position (equal to one standard lot), the leverage you gain from this is ten times on your account.
Similarly, the leverage is 20 times (200,000/10,000) if you use two standard lots. Thus, you can often see the previous trading results and calculate what leverage ratio they were following to acquire successful results. Again, this is quite essential for a new trader.
We hope that it would have become simple for you to calculate margin and leverage your trade wisely with this complete guide. All you need to do is be careful about applying the formula you are performing within.
See how the expert’s traders calculate their margins and leverage because it contributes to achieving maximum trade profits in your favour!
Jason Morgan is an experienced forex analyst and writer with a deep understanding of the financial markets. With over 13+ years of industry experience, he has honed his skills in analyzing and forecasting currency movements, providing valuable insights to traders and investors.
Forex Content Writer | Market Analyst