Leverage and Margin

<<<<<<< HEAD

Introduction

Even if traders are relatively successful in picking winners they may fail because they're under-capitalised and don't understand leverage.  In forex terms, some sources recommend opening the following accounts with the corresponding capital:

 Type of Account         Capital Required
 Standard Account
 At Least USD 100,000  EUR 75,000  GBP 65,000  AUD 100,000  CAD 100,000
 Mini Account At Least USD 10,000  EUR 7,500  GBP 6,500  AUD 10,000  CAD 10,000
 Micro Account At Least USD 1,000  EUR 750  GBP 650  AUD 1,000  CAD 1,000
Nb. Open a demo account before opening any of the above

Brokers will allow you to open an account with a few hundred £/$/€.  You need to understand leverage and margin before opening an account.  Having a small amount of capital will mean you are in serious risk of a 'margin call', even if you have a successful system.  We'll discuss 'margin call' later in this section.

Leverage Explained

Leverage is defined as "The use of various financial instruments or borrowed capital, such as margin, to increase the potential return of an investment."  The most common type of leverage is a mortgage on your home.  Basically you borrow money based on the capital you can put forward.  

For example you borrow £/$/€ 100,000 based on a £/$/€ 10,000 deposit at your broker.  Here the leverage terms at your broker are 10:1.  Here's the good news and the bad.  If you traded the £/$/€ 100,000 leverage and gained 10% of the levered amount you would have an extra £/$/€ 10,000 to your base capital.  That's a whopping 100%, Wow! On the reverse, if you loose 10% of the levered amount, then you loose ALL of your base capital. Trade carefully!

Below I've added a chart of how your account balance will change on a market move and your leverage.  This is a Forex example, but the numbers work for stocks, commodities etc.. too.


As you can see it only takes a small price change in your market to affect your overall account balance. Beware!!! 

Another way leverage can affect traders in a negative fashion is transaction costs.  The higher the leverage then the higher the costs on your margin per position.  For example if you have a 5 point spread on a trade and have 100:1 leverage (requiring a margin of 1%, or $100 on an $10,000 account- see below table), the relative cost to you for a $100 position will be $5, or 5%.  If you have 10:1 leverage then the same position on the 5 point spread will mean a 10% margin requirement.  The position will then cost you $1000.  That 5 point spread is now only 0.5% of your position.

Margin Explained

The 'Margin' is the amount traders need to deposit to open a position with your leveraged account. The below table expresses the relationship between margin required and leverage.

Relationship between Margin and Leverage

There are many brokers out there who will allow 10:1 leverage to 500:1 leverage.  They allow traders by buy such high positions by aggregating all their clients margin together for each trade.  Comparing brokers prior to trading is vital.  Use one of the broker guide web sites out there to do so.

Another way to look at Leverage and Margin Example: Barclay

In conventional dealing, you would have to pay your broker the total value of the shares you wish to purchase. Say you wished to purchase 10,000 Barclays shares and the current value of its shares is 260p. You would have to pay the total value of the shares purchased, i.e. £26,000 (10,000 x 260p).

With Leverage you only have to deposit a small percentage of the total trade value whilst maintaining the same level of exposure. If your broker charge a margin rate for Barclays of 15% of the total trade value, you would need to only deposit an initial £3900 (10,000 x 260p x 15%) plus commission to trade the same £26,000 exposure.

Margin Call Explained

When you open an account, say with £/$/€ 10,000 your usable margin will be £/$/€ 10,000, as is your equity.  As soon as your equity falls below (or equal to) your used margin you will have a margin call

Margin Call if Equity =< Used Margin

Let's look at an example of how equity and margin relate to each other and how a margin call might come about. Your first trade has a £/$/€ 100 risk associated with it (the max you will loose after placing your stop/loss).  As the value of this trade goes up or down, so will your equity, but your used margin will stay at £/$/€ 100 and your usable margin will be £/$/€ 9900.  If this trade goes against you you will loose your £/$/€ 100.  Your account will now look like this:

Equity (a running account balance)Used Margin (current risk in all open positions)Usable Margin (Equity - Used Margin)
9,90009,900

You decide to go stupid and risk £/$/€ 4,000 on your next trade.  As soon as you place the trade your account will look like this:

Equity (a running account Balance)Used Margin (current risk in all open positions)Usable Margin (Equity - Used Margin)
9,9004,0005,900

As of yet there is no margin call as equity is still greater than used margin.  This trade also goes against you and you loose your £/$/€ 4,000.  Your account now looks like this:

Equity (a running account Balance)Used Margin (current risk in all open positions)Usable Margin (Equity - Used Margin)
5,90005,900

You decide to play hard again and risk £/$/€ 4000. Your account now looks like this:

Equity (a running account Balance)Used Margin (current risk in all open positions)Usable Margin (Equity - Used Margin)
5,9004,0001,900

Initially this trade goes for you, so your equity will go up.  However, it turns against you and your equity then declines too (rem. used margin stays at £/$/€ 4,000).  As soon as your equity declines towards your used margin of £/$/€ 4,000 you are at risk of a margin call.  When it hits £/$/€ 4,000 there will be a margin call by your broker.  Your open position will be sold at current prices.  Your account after the margin call will look like:

Equity (a running account Balance)Used Margin (current risk in all open positions)Usable Margin (Equity - Used Margin)
4,00004,000

Make sure you monitor your account on a regular basis and use stop/losses to avoid margin calls and make sure you read your brokers policy on margin calls. 

Q1. I still don't understand Margin...

A: When you trade in the world financial markets, like for example buying shares you put up the money and buy the shares.

For example if you wanted to buy some shares in Vodafone because you think they are looking cheap and will go up then you could call up a broker, and if you wanted to invest £1000 he would buy as many shares as he could for you and take a small commission all out of your £1000.

Or you could do a margin trade, like a spread bet.  Say Vodafone has a margin rate of 10 % .  So if you wanted to buy your £1000 worth of Vodafone you would only need to deposit £100 (10 pct of £1000) with the spread betting company and leave the rest in your bank! So margin trading enables you to leverage.

Q2. How can I calculate Margin Requirements?

A. Margin Requirement is calculated as a percentage of the position. This percentage (Margin Factor) varies so first you must find the Margin Factor for your specific market. These are usually listed within the ‘Market Information’.

If the Margin Factor is expressed as a number:
 
Margin Requirement = Quantity x Margin Factor.
For example, if you want to open a Wall Street (Margin Factor = 400) position as a spread bet with a £10 stake. Margin Requirement = £10 x 400 = £4,000.

If the Margin Factor is expressed as a percentage: 

Margin Requirement = (Quantity x Our Price) x Margin Factor.
For example, if you want to buy 5,000 Vodafone CFDs (Margin Factor = 10%) and Offer Price is 1.49. Margin Requirement = (5,000 x 1.49) x 10% = £745.

Please note: For some markets such as gold, silver, bonds and options the margin calculations may differ from the examples above. 

Q3. How can I reduce margin requirements?

A. Your Margin Requirement may be reduced for a particular trade if you have a Stop Loss Order in place. 

To Sum Up

With leverage, small moves in price can result in quick margin calls.  You are more likely to have a margin call with leverage of 100:1 than 10:1.  Even with small risks on highly leveraged accounts margin calls can come incredibly quickly after a relatively short bad run.  Being properly capitalised means having enough of a margin to cope with your leverage.  Losses need to be absorbed, so it's advisable to open accounts with as low a leverage as you can handle.  Remember those transaction costs too - Broker want you to take highly leveraged positions and trade frequently.  It's how they make their money.  


=======

Introduction

Even if traders are relatively successful in picking winners they may fail because they're under-capitalised and don't understand leverage.  In forex terms, some sources recommend opening the following accounts with the corresponding capital:

 Type of Account         Capital Required
 Standard Account
 At Least USD 100,000  EUR 75,000  GBP 65,000  AUD 100,000  CAD 100,000
 Mini Account At Least USD 10,000  EUR 7,500  GBP 6,500  AUD 10,000  CAD 10,000
 Micro Account At Least USD 1,000  EUR 750  GBP 650  AUD 1,000  CAD 1,000
Nb. Open a demo account before opening any of the above

Brokers will allow you to open an account with a few hundred £/$/€.  You need to understand leverage and margin before opening an account.  Having a small amount of capital will mean you are in serious risk of a 'margin call', even if you have a successful system.  We'll discuss 'margin call' later in this section.

Leverage Explained

Leverage is defined as "The use of various financial instruments or borrowed capital, such as margin, to increase the potential return of an investment."  The most common type of leverage is a mortgage on your home.  Basically you borrow money based on the capital you can put forward.  

For example you borrow £/$/€ 100,000 based on a £/$/€ 10,000 deposit at your broker.  Here the leverage terms at your broker are 10:1.  Here's the good news and the bad.  If you traded the £/$/€ 100,000 leverage and gained 10% of the levered amount you would have an extra £/$/€ 10,000 to your base capital.  That's a whopping 100%, Wow! On the reverse, if you loose 10% of the levered amount, then you loose ALL of your base capital. Trade carefully!

Below I've added a chart of how your account balance will change on a market move and your leverage.  This is a Forex example, but the numbers work for stocks, commodities etc.. too.


As you can see it only takes a small price change in your market to affect your overall account balance. Beware!!! 

Another way leverage can affect traders in a negative fashion is transaction costs.  The higher the leverage then the higher the costs on your margin per position.  For example if you have a 5 point spread on a trade and have 100:1 leverage (requiring a margin of 1%, or $100 on an $10,000 account- see below table), the relative cost to you for a $100 position will be $5, or 5%.  If you have 10:1 leverage then the same position on the 5 point spread will mean a 10% margin requirement.  The position will then cost you $1000.  That 5 point spread is now only 0.5% of your position.

Margin Explained

The 'Margin' is the amount traders need to deposit to open a position with your leveraged account. The below table expresses the relationship between margin required and leverage.

Relationship between Margin and Leverage

There are many brokers out there who will allow 10:1 leverage to 500:1 leverage.  They allow traders by buy such high positions by aggregating all their clients margin together for each trade.  Comparing brokers prior to trading is vital.  Use one of the broker guide web sites out there to do so.

Another way to look at Leverage and Margin Example: Barclay

In conventional dealing, you would have to pay your broker the total value of the shares you wish to purchase. Say you wished to purchase 10,000 Barclays shares and the current value of its shares is 260p. You would have to pay the total value of the shares purchased, i.e. £26,000 (10,000 x 260p).

With Leverage you only have to deposit a small percentage of the total trade value whilst maintaining the same level of exposure. If your broker charge a margin rate for Barclays of 15% of the total trade value, you would need to only deposit an initial £3900 (10,000 x 260p x 15%) plus commission to trade the same £26,000 exposure.

Margin Call Explained

When you open an account, say with £/$/€ 10,000 your usable margin will be £/$/€ 10,000, as is your equity.  As soon as your equity falls below (or equal to) your used margin you will have a margin call

Margin Call if Equity =< Used Margin

Let's look at an example of how equity and margin relate to each other and how a margin call might come about. Your first trade has a £/$/€ 100 risk associated with it (the max you will loose after placing your stop/loss).  As the value of this trade goes up or down, so will your equity, but your used margin will stay at £/$/€ 100 and your usable margin will be £/$/€ 9900.  If this trade goes against you you will loose your £/$/€ 100.  Your account will now look like this:

Equity (a running account balance)Used Margin (current risk in all open positions)Usable Margin (Equity - Used Margin)
9,90009,900

You decide to go stupid and risk £/$/€ 4,000 on your next trade.  As soon as you place the trade your account will look like this:

Equity (a running account Balance)Used Margin (current risk in all open positions)Usable Margin (Equity - Used Margin)
9,9004,0005,900

As of yet there is no margin call as equity is still greater than used margin.  This trade also goes against you and you loose your £/$/€ 4,000.  Your account now looks like this:

Equity (a running account Balance)Used Margin (current risk in all open positions)Usable Margin (Equity - Used Margin)
5,90005,900

You decide to play hard again and risk £/$/€ 4000. Your account now looks like this:

Equity (a running account Balance)Used Margin (current risk in all open positions)Usable Margin (Equity - Used Margin)
5,9004,0001,900

Initially this trade goes for you, so your equity will go up.  However, it turns against you and your equity then declines too (rem. used margin stays at £/$/€ 4,000).  As soon as your equity declines towards your used margin of £/$/€ 4,000 you are at risk of a margin call.  When it hits £/$/€ 4,000 there will be a margin call by your broker.  Your open position will be sold at current prices.  Your account after the margin call will look like:

Equity (a running account Balance)Used Margin (current risk in all open positions)Usable Margin (Equity - Used Margin)
4,00004,000

Make sure you monitor your account on a regular basis and use stop/losses to avoid margin calls and make sure you read your brokers policy on margin calls. 

Q1. I still don't understand Margin...

A: When you trade in the world financial markets, like for example buying shares you put up the money and buy the shares.

For example if you wanted to buy some shares in Vodafone because you think they are looking cheap and will go up then you could call up a broker, and if you wanted to invest £1000 he would buy as many shares as he could for you and take a small commission all out of your £1000.

Or you could do a margin trade, like a spread bet.  Say Vodafone has a margin rate of 10 % .  So if you wanted to buy your £1000 worth of Vodafone you would only need to deposit £100 (10 pct of £1000) with the spread betting company and leave the rest in your bank! So margin trading enables you to leverage.

Q2. How can I calculate Margin Requirements?

A. Margin Requirement is calculated as a percentage of the position. This percentage (Margin Factor) varies so first you must find the Margin Factor for your specific market. These are usually listed within the ‘Market Information’.

If the Margin Factor is expressed as a number:
 
Margin Requirement = Quantity x Margin Factor.
For example, if you want to open a Wall Street (Margin Factor = 400) position as a spread bet with a £10 stake. Margin Requirement = £10 x 400 = £4,000.

If the Margin Factor is expressed as a percentage: 

Margin Requirement = (Quantity x Our Price) x Margin Factor.
For example, if you want to buy 5,000 Vodafone CFDs (Margin Factor = 10%) and Offer Price is 1.49. Margin Requirement = (5,000 x 1.49) x 10% = £745.

Please note: For some markets such as gold, silver, bonds and options the margin calculations may differ from the examples above. 

Q3. How can I reduce margin requirements?

A. Your Margin Requirement may be reduced for a particular trade if you have a Stop Loss Order in place. 

To Sum Up

With leverage, small moves in price can result in quick margin calls.  You are more likely to have a margin call with leverage of 100:1 than 10:1.  Even with small risks on highly leveraged accounts margin calls can come incredibly quickly after a relatively short bad run.  Being properly capitalised means having enough of a margin to cope with your leverage.  Losses need to be absorbed, so it's advisable to open accounts with as low a leverage as you can handle.  Remember those transaction costs too - Broker want you to take highly leveraged positions and trade frequently.  It's how they make their money.  


>>>>>>> c0fd65f8ac5b5830dc3df1d307fcababd602b3a9
Comments