All About Leverage, Margins, and Margin Calls!

Leverage is borrowing money with the main goal of earning greater return than the cost of interest. Leveraging as you can see has the power to greatly increase potential return but it also comes with increased risk on your investment. (e.g. Lehman Brothers went down because of excessive leverage).

So how does leverage work in Forex?

Well leveraging a position means putting down collateral know as Margin. Margin is simply a form of borrowed money that allows you to take a position that is greater in value. This in other words is the money that will be used by your broker to cover any losses incurred on your part.

A leverage of 1:100 means that you can control $100000 with as little as $1000 in your account! Thus you pay only 1% of the position with the money that you have and you borrow the rest.

To make this clear, for example let’s say that you have $10,000 in your account.

You buy 1 lot of EUR/USD at a price of 1.2300 with the 100:1 maximum leverage. Your utilized margin is $1000. If the position makes money, the gains are added to the equity of your account.On the other hand, if it goes against you the losses are subtracted from the account’s total equity.

Lets say that price moves 100 pips in your favor. This means that you would make a $1,000 profit ($10 per pip × 100 pips).

On the other hand, if position goes against you by at least 100 pips, your position would have been closed due to a margin call when you account equity dropped below the $1000 margin requirement. This would cause you a loss of approximately $1000.

Margin calls exist in order to protect the brokerage firms. Thus, you as an investor must maintain adequate capital, which is the minimum margin requirement to prove that the margin can be repaid.

In an event that an investment is going against you and is losing value, the brokerage firm can give you a margin call with the option of:

• Depositing more money to maintain capital or
• Sell your investments to maintain a good balance to margin ratio.

In case you decide not to sell your investments and simply ignore the call, the firm has the power to liquidate your investments for you. At this point, you will have no control over which investments are sold.

My word of advice is to be very careful with margin. The best thing to do is to use a lower leverage (10:1 or 2:1). This will ensure that you’re in the game longer.

Happy trading.

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