How Margin Is Calculated
Forex trading leverage is the main resource for forex traders: it is the mechanism that allows moving amounts far greater than those deposited in one's trading account (initial margin). The margin is the amount required as a guarantee to open a single trade. To quickly calculate the percentage of margin required by the broker, it is necessary to divide 100 by the leverage ratio. For example, with a 1:100 leverage, the required margin will be 1% (100/100). For a fuller picture of these mechanics, see liquidity, volatility, and leverage basics.
To understand how much money is needed to open a single trade, consider a simple practical example. Suppose a trader deposits 2,000 euros into the account and works with a 1:100 leverage, then decides to buy a contract of 10,000 EUR/USD at 1.40. The required margin will be: 100/100 = 1% = 0.01. The margin required for the single trade will be equal to: 1.40 * 10,000$ * 0.01 = 140$.
The Earning Potential of High Leverage
Most brokers offering foreign exchange intermediation services allow traders to work with leverage up to 200 times higher than the amount actually deposited into the account (1:200 leverage). This means that with an account opened with 1,000 euros, it is possible to invest up to 200,000 euros even without having all this money! It's clear that the extraordinary earning potential that this market offers immediately catches the eye. For example, buying a contract of 200,000 EUR/USD on the expectations of a rise in this exchange rate, a 1% favorable movement immediately produces a profit of 2,000 euros. Considering that only 1,000 euros are available in the account, the return on invested capital (ROI) will be equal to 200%!
The Risk of a Margin Call
What happens, instead, if the trade loses 1%? The loss would be 2,000 euros, but with only 1,000 euros in the account, the broker automatically closes the position before the account is zeroed out, subsequently proceeding with the so-called margin call, which is the invitation to restore the initial margin in order to continue trading. In any case, when opening an account, it is always better to inquire in advance about the broker's margin management to avoid losing more than the capital actually deposited. The example proposed earlier served to highlight the extraordinary earning opportunities that this market can offer to the most prepared traders, but it is an extreme case because, for example, it does not take into account the trader's risk tolerance level and financial capacity.
Avoiding Over-Leverage
Financial leverage should be used accurately, trying to avoid the so-called over-leverage, which is an excessive exposure in relation to the money actually deposited into the account. Leverage allows amplifying gains, but also losses! The correct use of leverage is based on the concept of diversification: a trader can buy and sell many exchange rates considered potentially profitable while having a small amount in the account. However, careful analysis of the overall risk taken on in each operation is needed to avoid exposure to initially unforeseen losses in the market.
