What is margin and leverage in trading?

Online trading is so popular that most people you know probably hold an account with a trading platform. You may even hear them talk about large positions or how they made a solid profit in the forex market out of small fluctuations in currency values. And then you ask yourself how much capital they needed to get started in the first place. The answer may surprise you.

Depending on which instrument you’re interested in and which broker you hold a trading account with, you may be able to buy on margin. This means that you only need to put down a small amount (margin) to gain access to a large position (leveraged position). The leverage is the loan the broker gives you to help you access the position, which you wouldn’t otherwise be able to afford, and it’s particularly important in forex trading where you need a large position in order to benefit from small price fluctuations.

So how do I benefit from leverage?

First of all, start by selecting the best trading platform for your needs. Check the leverage they offer and the terms and conditions it comes with. Depending on the instrument, the broker will expect you to put down a certain amount of capital, which is called the initial margin. The broker will then multiply your capital by a factor determined by the leverage and give you access to a larger position. E.g. if you want to open a position for 2,000 units in the GBP/USD currency pair and the broker offers a 200:1 or 0.5% leverage, you only need to put down £10.

It all sounds pretty amazing, and it is if you understand how to manage leverage. As a novice, it’s important to remember that it multiplies the opportunity but it also multiplies the risk . Make sure you research any fees and take note of the maintenance margin, which is the equity you need to maintain in your account in order for the broker to keep your position open.

Bitesize basics
  • Leverage is a loan your broker gives you and it allows you to open a large position, which you couldn’t afford otherwise.
  • The initial margin is the capital you need to put down in order to get access to the leveraged position.
  • Leverage is the factor by which the broker will multiply your capital.
  • Maintenance margin is the account balance you need to maintain in order for the broker to keep your position open.

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