What Is Leverage and Margin?

We've covered this topic before, but it is so crucial for traders that it deserves a detailed explanation once again.

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Leverage: How It Works and Its Risks

Leverage is a tool that allows traders to control large trading positions while using only a fraction of their own funds. The remaining capital is borrowed from the broker.

📌 Example:
You want to open a $100,000 position, but you only have $1,000 in your account. If your broker offers 100:1 leverage, they will reserve $1,000 from your balance while covering the rest through leverage.

This means you control $100,000 while actually having only $1,000 in your account.

Now imagine the price of your asset rises by $1,000:

✅ If you traded without leverage (1:1), your profit would be 1% ($1,000 from a $100,000 investment).
✅ But with 100:1 leverage, your actual deposit was only $1,000, yet your profit remains $1,000. This means a 100% return on investment.

At this stage, leverage seems like a magical tool. But now consider what happens if the price drops by $1,000:

❌ With 1:1 leverage, you lose only 1% of your capital.
❌ With 100:1 leverage, you lose EVERYTHING, because a $1,000 loss equals 100% of your deposit.

💡 This is why traders often say, "Leverage is a double-edged sword." It amplifies both potential profits and the risk of wiping out your account.

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What Is Margin and Why Is It Important?

Margin is the amount of money that the broker reserves from your account as collateral to maintain an open trade. These funds are not deducted from your balance but are locked until the trade is closed.

📌 Example:
✔ You open a trade worth $100,000.
✔ Your broker requires 1% margin.
✔ This means $1,000 will be reserved from your account.

💡 Essentially, margin is your required deposit for trading with leverage.

How Brokers Calculate Maximum Leverage?

Your broker determines maximum allowable leverage based on the percentage of required margin.

Margin Requirement	Maximum Leverage
5.00%	20:1
3.00%	33:1
2.00%	50:1
1.00%	100:1
0.50%	200:1
0.25%	400:1

The lower the margin requirement, the higher the available leverage. However, the higher the leverage, the greater the risk of liquidation.

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Types of Margin: What Every Trader Should Know

Your trading platform may show different types of margin. Let’s break down the key terms:

1️⃣ Required Margin – The amount the broker locks to open a trade, usually expressed as a percentage of the total position.

2️⃣ Account Margin – Your total account balance, including free and reserved funds.

3️⃣ Used Margin – The money already reserved by the broker to maintain open trades. These funds cannot be used until a trade is closed.

4️⃣ Free Margin – The money available to open new trades. More free margin = more trading opportunities.

5️⃣ Margin Call – A warning from the broker when your account balance drops below the required margin level. If not funded, the broker will automatically close positions to prevent further losses.

🚨 A margin call is a trader’s worst enemy!

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Conclusion: Key Takeaways About Leverage and Margin

📌 Golden Rules for Using Leverage Safely:
✅ The higher the leverage, the greater the risk of losing your deposit.
✅ Avoid leverage above 1:10, unless you are comfortable with aggressive risks.
✅ Lower margin requirements increase trading risk.
✅ Monitor your free margin to prevent margin calls.
✅ If your account balance is small, avoid high leverage—it almost guarantees a loss.

 

💡 Final Thought:
Leverage is a powerful tool that can either accelerate your capital growth or wipe it out in seconds. Proper risk management and a deep understanding of margin mechanics are essential for every successful trader. 🚀