Posts Tagged ‘leverage’

03.04.2012 Post in Trading

Margin trading (or trading with the leverage) is a specific peculiarity of financial markets and a very attractive opportunity for traders. Thanks to the cash borrowed from a broker investors are able to carry out trades with volumes that exceed several times the size of their own capital.

To get a loan an investor should deposit a required sum of money– a margin that serves as collateral and prevents the client’s debt obligations from growing. A margin ensures that losses of a trader will not exceed the actual size of deposit. If losses are approaching the size of margin, a trader should replenish the trading account. Otherwise broker will automatically close all open positions. A signal indicating that a trader should replenish the deposit is called margin call.

creditThe sum of a margin (collateral) depends on the size of the leverage and volume of trades. For example, with 1:100 leverage and $100 equity, a trader will get $10000 to carry out deals. If you open a $ 5000 deal, then considering the leverage, a margin should be $50, i.e. client’s funds cover only a part of a deal, the rest is paid by money borrowed from the broker. If the deal is closed with profit, then all the money get with the help of the leverage is transferred to trader’s account. Thus, with favorable circumstances it is possible to improve your financial situation quickly and effectively. Margin is frozen in the trading account; a trader is free to use the rest of the deposit. If a trader suffers losses that exceed the certain part of the collateral, positions can be closed automatically. Different brokerage firms set different margin call requirements.

If you would like to avoid a margin call, you should use limiting orders as Stop Loss and Take Profit as they will allow you to set the target profits and permissible loss level.

On Forex the leverage is provided for free and for unlimited term unlike stock markets that usually charge for this service. While opening a margin account with Forex-broker a trader usually can define at once the size of leverage and begin to carry out deals. Some years ago 1:200 leverage was astonishing. Nowadays brokers can provide their clients with 1:1000 leverage! But as a rule traders are satisfied with 1:50 and 1:100 leverages. Some traders prefer 1:5 leverage and some of them refrain from using leverages. In short, everything depends on strategy and trading style.

It is necessary to keep in mind that big profits are always related to big risks. The higher the leverage is, the higher the risk of losing a deposit is. You should choose the leverage according to your experience.

The usage of the leverage will be effective and justified if your approach to money management is reasonable. Also it is necessary to control the equity and refrain from opening deals with huge lots. In this case the profitability of deals can be increased significantly.

Added by Roman Tsepelev,
InstaForex development manager