In the world of trading, you encounter different terms and phrases that may not be meaningful at first to you. There are also some that you may confuse with another, like margin and leverage.
Margin and leverage are two of the most commonly used words in the world of trading. These two are also the most often used tools among traders. And these two are also the most commonly confused words by investors.
In this article, we’re going to demystify the two words and define them, clarifying their similarities and differences. So read on and learn more about margin and leverage!
What is Leverage?
When you look up the meaning of leverage, you would find that it’s defined as the ability to control a big amount of money with just a very small amount of your own money while borrowing the rest.
For instance, in order for you to control $100,000 position, your broker will just use $1,000 from your account. Leverage is expressed in ratios, so you can then say that your leverages is at 100:1. You are thus controlling $100,000 with just $1,000.
What is Margin?
To define what margin is, we will use the example above again.
Your controlling a $100,000 position with just $1,000 set aside by your broker from your account. Your leverage is at 100:1. Think of the $1,000 deposit as you “margin,” which you had to give if you want to use the leverage.
Therefore, margin refers to the amount of money that you need to deposit if you want to open a position with your broker.
This margin is used by your broker to maintain your position. What your broker basically does is take your margin position and pool them with everyone else’s margin deposits. The broker then uses the large sum of margin deposits in order to place trades within the interbank network.
If leverage is expressed in ratios, margin, on the other hand, is expressed as a percentage of the full amount of the position. For instance, many forex brokers usually require 2 percent, 1 percent, .5 percent, or .25 percent margin.
Terms Related to Margin and their Meanings
There are a lot of confusions when it comes to margin and leverage, but many of such confusions come from the terms and phrases related to margin. Here are some of the important definitions you have to remember.
This is the amount of money that your broker requires from you if you want to open a position.
This refers to the amount of the money you have in your trading account.
This is the amount of money that your broker has “locked up” for you to keep your current positions open.
The used margin is yours, of course. But you won’t be able to use it until your broker hands it back to you either when you close your current positions or when the unfortunate time of margin call comes.
This refers to the money in your account that you can use to open new positions.
You get this “call” when the amount of money that’s in your account does not suffice to cover your possible loss. This takes place when your equity falls lower than your used margin. If a margin call happens, some or all of your open positions will be closed by the broker at market price.