Leverage and Margin
Margin and leverage go hand in hand. Margin in FOREX is basically collateral (or a security deposit) to take on a position. Leverage on the other hand will affect what your margin would be to take on a position. Typical leverage in the Forex market would consist of the following table. In other words, the more leverage you have, the less margin you need to take on that position.
Please be advised that Leveraged foreign exchange trading carries a high level of risk, and many not be suitable for all investors. The possibility exists that you could sustain a loss of some or all of your initial investment and therefore you should not invest money that you cannot afford to lose.
Margin as a Ratio Margin as a Percentage
Let’s take an example here. You have a leverage of 100:1 with a balance of $5,000 and you go long one standard lot on the EUR/USD at 1.3436. What would be your margin?
One standard lot (1.00) is equivalent to 100,000 base currency units (bcu’s). A 100:1 leverage is one percent so one percent of 100,000 bcu’s would give you a margin requirement of 1,000 Euros. Now please take notice that the base currency unit is always the first currency in the pair. In this case, the bcu is the Euro. Therefore, every standard lot you take a position in, you would be required to put up a margin of 1,000 Euros.
Now, what would be the margin requirement in US dollars? Well, we would have to simply convert the 1,000 Euros to US dollars using the exchange rate of 1.3436 where we went long. So in US dollars, your margin would be 1.3436 x 1000 Euros = $1343.60. There you go, so for each standard lot you take a position in for this pair, you would be required to put up $1343.60 as collateral (margin).
Well why now is margin so important? Technically, with $5,000 you can buy three standard lots. $1343.60 x 3 = $4030.80. So in essence, you are putting up a security deposit (margin) of $4030.80 to control three standard lots at one time. With standard lots every pair with the USD as the counter pair (the second currency in the pair) would equate to $10 per pip. So, for instances, we are long three standard lots at 1.3436 and the EUR/USD moves upward to 1.3466 and we close (sell) our position. That is a 30 pip move and at $10 per pip with three lots, that’s a profit of $900 (3 standard lots x $10 per pip x 30 pip movement). Similarly, a 30 pip downward movement would result in a $900 loss.
Here is a very important lesson so you do not get caught with a margin call (when your broker liquidates your position so there is limited risk of you going into debit)
As you can see from the above example, you have $4030.80 tied up as a security deposit (margin) and with a total balance of $5,000 you have $969.20 left remaining ($5,000-$4030.80 = $969.20). If your account loses more than $969.20, your three standard lots of the EUR/USD will be liquidated. For simplicity sakes, let’s say you lost 969.20 and you did in fact incur a margin call. After the margin call, you will have no position open and a remaining balance of $4030.80. With your account balance at $4030.80 after the margin call you have no open position and you are free to start trading again. There is no time line to trade again after you get a margin call in Forex.
Well, what about if you are trading mini or mico-lots? Let’s proceed….. As you now know, one standard lot (1.00) is 100,00 bcu’s. So, one mini-lot (0.10) would be 10,000 bcu’s and one micro lot (0.01) would be 1,000 bcu’s.
Consequently, with a one mini lot (0.10) with leverage of 100:1 your margin would for the EUR/USD would be 1 percent of 10,000 which is 100 bcu’s or 100 Euros. As a result, converting 100 Euros to US dollars would be? 1.3436 x 100 = $134.36. The EUR/USD with a mini-lot (0.10) or any pair with the counter currency (second currency pair) as the US dollar would be $1.00 per pip. And with a micro-lot (0.01) would be $0.10 per pip.
Why don’t we do another example with a 200:1 leverage instead? What would our margin be with a leverage of 200:1 with one standard lot? From the table above you will notice that a 200:1 leverage as a percent would be 0.50%. Thus, if taking a position in the EUR/USD your margin would be 100,000 bcu’s x 0.50 percent = 500 bcu’s or 500 Euros.
Converting to US dollars your required margin for each standard lot would be 500 Euros x 1.3436 = $671.80.
For a mini-lot it would be 10,000 bcu’s x 0.50 percent = 50 Euros. In US dollars, you margin would equate to 50 Euros x 1.3436 = $67.18
And last but not least, a micro-lot would be 1,000 bcu’s x 0.50 percent = 5 Euros for your margin requirement which is $6.71 (5 x 1.3436 = $6.71)
Work in progress……