Understanding Leverage - What You Don't Know Can Hurt You
Leverage Ratio and Minimum Margin Requirements
- Leverage is expressed as a ratio and is based on the margin requirements imposed by your broker.
- For example, if your broker requires you to maintain a minimum 2% margin in your account, this means that you must have at least 2% of the total value of an intended trade available as cash in your account, before you can proceed with the order.
- Expressed as a ratio, 2% margin is equivalent to a 50:1 leverage ratio (1 divided by 50 = 0.02 or 2%). The following table shows the relationship between leverages and minimum margin requirements:
Comparison of leverage ratios and the minimum margin requirements expressed as a percentage.
If Leverage Ratio is... Then, the Minimum Required Margin equals... 100:1 1% 50:1 2% 40:1 2.5% 30:1 3.3% 20:1 5% 10:1 10%
- As a trader, it is important to understand both the benefits, and the pitfalls, of trading with leverage.
- Using a ratio of 50:1 as an example, means that it is possible to enter into a trade for up to 50 dollars for every dollar in the account.
- This is where margin-based trading can be a powerful tool – with as little as $1,000 of margin available in your account, you can trade up to $50,000 at 50:1 leverage.
- This means that while only committing $1,000 to the trade, you have the potential to earn profits on the equivalent of a $50,000 trade.
- Of course, in addition to the earning potential of $50,000, you also face the risk of losing funds based on a $50,000 trade, and these losses can add up very quickly.
- Traders suffering a loss without sufficient margin remaining in their account run the risk of triggering a margin closeout.
OANDA caps leverage at a maximum of 100:1 for all traders. As a new trader, you should consider limiting your leverage even further to a maximum of 20:1, or even 10:1. Trading with too high a leverage ratio is one of the most common errors committed by new forex traders. Therefore, until you become more experienced, OANDA strongly urges you to trade with a lower ratio.
The profit or loss for a trade is not realized until the trade is closed. An open trade or position is said to be unrealized.
- When trading on leverage, the funds in your account (the minimum margin) serve as your collateral.
- Therefore, it is only natural that your broker will not allow your account balance to fall below the minimum margin.
- When you have one or more open trades, your broker continually calculates the unrealized value of your positions to determine your Net Asset Value (NAV) .
- Should your open positions lose so much potential value that the remaining funds in your account – that is, your remaining collateral – is in danger of falling below the minimum margin limits, you could receive a margin closeout.
- At OANDA, a margin closeout will cause all tradable, open positions in your account to automatically close at the current fxTrade rates at the time of closing.
- For this reason, it is to your advantage to avoid margin closeout. We'll discuss strategies to avoid a margin closeout in Lesson 4 – Making That First Trade.
Net Asset Value (NAV) refers to the value of all assets, minus all liabilities. When you have open positions, your NAV is calculated as the total assets in your account, plus the theoretical value of your open positions. This value is obtained by calculating the value of your positons if they were closed at the current market rate.
The Commodity Futures Trading Commission (CFTC) limits leverage available to retail forex traders in the United States to 50:1 on major currency pairs and 20:1 for all others. OANDA Asia Pacific offers maximum leverage of 50:1 on FX products and limits to leverage offered on CFDs apply. Maximum leverage for OANDA Canada clients is determined by IIROC and is subject to change. For more information refer to our regulatory and financial compliance section.
This is for general information purposes only - Examples shown are for illustrative purposes and may not reflect current prices from OANDA. It is not investment advice or an inducement to trade. Past history is not an indication of future performance.