Hello and Welcome to the ditto educational series that will provide you with the skills you need to become a Forex trader!
What is Leverage?
Leverage is the ratio of a company’s loan capital or(debt) to the value of its shares or (equity).
The process of leverage is used by both investors and companies. Investors can use leverage to massively increase their potential returns that can be provided on an investment.
They can leverage their investments by using various instruments that include futures, options and margin accounts.
So Basically what we are saying is Companies can use leverage to finance their assets. instead of issuing stock to raise capital, companies can use leverage as a form of debt financing to invest in business operations in an attempt to increase shareholder value.
Now that’s all well and good, so how does this apply to us Using Leverage in Forex?
In the Forex market traders use leverage to profit from the fluctuations in exchange rates between two different countries currencies or pairs.
The leverage that is offered in the Forex market is one of the highest that investors can obtain. Leverage is initiated through a loan that is provided to an investor by the broker that is handling the investor’s or trader’s Forex account. As already stipulated this is a form of debt financing.
When you decide to embark on becoming a Forex trader ,in order to trade you must first open a margin account with a Forex broker.
the amount of leverage options provided are usually 50:1, 100:1 or 200:1, depending on the broker and the size of the position that the investor is trading.
Some brokers do offer higher leverage options but not always.
Let’s use the 100:1 ratio as an example. 100:1 in leverage means that the trader is required to have at least 1% of the total value of trade available as cash in their trading account.
Ordinarily trading is done on 100,000 units of currency. for a trade of this size, the leverage provided is normally 50:1 or 100:1. Leverage of 200:1 is usually reserved for positions of $50,000 or less.
If we want to trade $100,000 of currency, with a margin of 1%, a trader will only have to deposit $1,000 into their margin account in order to execute the trade.
The reason brokers can provide such high leverage and the reason why this is not a huge risk is because typically the Forex market price only changes on a daily rate between 1 percent or less. If foreign currencies were as volatile as equities and futures this sort of leverage would not be possible.
Now Leverage Can Hurt us as much as it can help us when trades do not behave as expected. The ability to quickly gain massive profit is only matched by our ability quickly incur massive losses where leverage is concerned. We have talked about risk reward and placing stop losses in accordance with what we can afford to lose and this is why. Don’t begin trading until you understand to potential pitfalls and risk at hand.
Now we have that covered let’s take a look at margin:
What is Margin?
All brokers have different margin requirements so it’s good to understand the basis of how it all works, before you choose a broker and begin trading.
A Forex margin is basically a balance that is required to maintain open positions on your account. It’s a percentage of your account equity set aside and assigned as a margin deposit.
Trading on a margin can influence your trading experience greatly by allowing larger profits to be made but also larger potential losses can occur.
Your broker takes your margin deposit and then pools it with other traders margin Forex deposits. They do this in order to be able to place trades within a InterBank network.
Your margin is often shown as a designated percentage of the full amount of the chosen position.
What is a Free Margin in Forex?
Free margin is basically the amount of capital you have which is not involved in any trade. It is freely available so that you may take up more positions in the market.
the free margin also represents the difference between your equity and margin.
When your open positions grow in value and achieve greater profits the result is an increase in equity, due to this you will have an increased free margin as a result.
You may have experienced this before or heard of another trader saying that their broker failed to initiate a pending order that was set up and as a result they lost out on some big potential profits! Sound familiar? If there is not enough free margin available on your account due to low balance or more likely open trades the pending order will not trigger or be cancelled by the broker.
What is a Forex Margin Level?
Forex margin level is something that is quite important and you do need to understand it and it’s application. The Forex margin level is the percentage value based on the amount of accessible usable margin versus used margin.
Put more simply it is the ratio of equity to margin. We can express this as the following calculation.
Margin level = (equity/used margin) x 100.
Brokers can use margin levels in an attempt to detect whether traders can take on any new positions.
Usually brokers will set this limit at 100%. This limit is called a margin call level.
when your account margin level reaches 100%, you can still close your open trade positions, but you cannot take any new positions.
100% margin call levels occur when your account equity is equal to the margin. This can occur when you have one or multiple losing positions and your trades are losing continuously and quickly.
When account equity equals the margin, you will not be capable of opening any new positions. Understanding the basics of leverage and margin can make you a more prepared and all around efficient trader as well as help you understand the risk and reward involved. Be sure to monitor your account closely and always use a pre-calculated stop loss.
I hope you enjoyed today’s video ladies and gentlemen please sit back and contemplate what you have learned today, as always contemplation is the key to learning.