Trading on margin allows traders to increase their buying power by only putting up a fraction of the total trade value. This enables them to control larger positions than what their initial capital would typically allow.
Margin: The minimum deposit required to open a leveraged position.
Leverage: The ratio of the trader’s capital to the total position size (e.g., 1:5, 1:30).
Leverage essentially amplifies both potential gains and losses, making it a high-risk, high-reward strategy.
A margin call occurs when a trader’s equity falls below the required maintenance margin level. This means the broker requires the trader to add more funds or close some positions to avoid liquidation.
If a trader ignores a margin call and their margin drops below the stop-out level, the broker will automatically close positions to prevent further losses.
Leverage allows traders to maximize returns on a smaller capital investment.
Example:
Suppose a trader wants to buy 100 stocks at $150 each.
Without leverage, they would need $15,000.
With a 1:5 leverage, they only need to invest $3,000 as margin.
If the stock price rises by $5, the total profit would be $500 instead of just $100 without leverage.
Leverage is a double-edged sword—while it increases potential profits, it also magnifies losses.
Using the same example:
If the stock price drops by $5, the loss would be $500 instead of just $100.
This can quickly deplete the trader’s margin and lead to a margin call or forced liquidation.
Consider a trader placing a forex trade on EUR/USD using a 1:30 leverage:
The trader deposits $1,000 as margin.
Maximum trading power: $1,000 × 30 = $30,000 (0.3 lots).
To reduce risk, the trader opens a 0.1 lot ($10,000) trade, using only $333.33 of their margin.
If the trade moves 10 pips against them, they lose $10.
If it moves 10 pips in their favor, they gain $10.
Leverage and margin allow traders to maximize potential returns, but they also increase exposure to risk. Managing risk through stop-loss orders, proper position sizing, and risk assessment is crucial to avoid large losses.
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