Leverage and Margin

Knowledge of leverage and margin is fundamental for CFD traders to maximize their trading opportunities while maintaining control over their exposure to market volatility.

What is Leverage?

Leverage in trading involves using borrowed capital to amplify potential returns on an investment. For example, with 1:500 leverage, a trader can significantly increase their potential profits, but this also magnifies the risk of losses. If the market moves in the trader’s favor, profits can be much higher compared to trading without leverage. However, if the market moves against the trader, losses are equally amplified.

What is Margin?

Margin is the amount a trader needs to deposit to open or maintain a leveraged position. For example, if a broker that requires a 2% margin for a trade worth $10,000. In this case, the trader needs to deposit just $200 (2% of $10,000) to enter the trade. This $200 deposit is not a fee but a part of the trader’s funds set aside as collateral. If the market moves in an unfavorable direction and the value of the trade decreases, the trader may receive a ‘margin call’, necessitating an additional deposit to keep the position open or risk having the position closed by the broker.

Let’s make a comparison between margin & leverage:

Margin allows traders to participate in markets with less capital by enhancing their buying power. It helps in diversifying investments and enables access to markets that usually require high capital. However, using margin increases the risk of losses, especially if the market moves unfavorably, potentially triggering margin calls. Interest charges on borrowed funds can accumulate, and the increased buying power may lead to impulsive or high-risk trading.

Leverage increases the potential returns on investment by providing the ability to trade in various markets with limited capital. On the downside, leverage can result in losses that exceed the initial investment, adding significant risk. It can lead to rapid losses in volatile conditions and requires careful risk management and constant market monitoring.