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Leverage and margin

Leveraged or margined trading allows you to leverage the funds in your account to potentially generate larger profits than your initial investment.

Leverage and margin COVER

Leverage and margin trading in forex

Leveraged or margined trading allows you to leverage the funds in your account to potentially generate larger profits than your initial investment. The flipside to this is that you can also potentially incur significant losses if the market moves against you. At OANDA, leveraged or margined trading enables you to open positions that are larger than your account balance.

To minimise your losses and reduce the negative effect of leverage on a losing trade, it’s always a good idea to use a stop loss and maintain at least a 1:1 risk-reward ratio on all your trades.

What is the difference between leverage and margin in forex?

When you open a live account, you make a deposit, and this is known as margin. This margin can be used in a similar way as a downpayment on a mortgage: since you now have leverage on your margin, you will be able to open trades by putting down a fraction of the full value of your trade. Your broker is effectively lending you the rest.

Leverage is described as a ratio or multiple. So, for example, leverage of 1:100 means that for every US$1 you have in your account, you can place a trade worth up to US$100. For instance, say you are looking to take a position on a forex pair. With a leverage of 1:30, for every US$1 you have in your account you can place a trade worth up to US$30, and so on.

How does leveraged trading work?

Trading with leverage allows you to trade in markets that would otherwise be unavailable to you. Once you understand how leveraged trading works, it can be a powerful tool to maximise your profits: with just a fraction of the value of your trade, you can make the same profit as in a conventional trade.

How does leveraged trading work?

The price increase in your favour at the time of closing your trade is multiplied by the leverage you are working with. Remember, however, that leveraged trading is a double-edged sword: if the market moves in the opposite direction of your trade, you could just as easily rack up losses that are greater than your initial investment. You can manage your risks by placing a stop-loss order on your trades.

Managing your risk in leveraged trading

To mitigate the risks of leveraged trading, you can make use of stops.

Understanding margin calls and margin closeouts

Margin calls are an important aspect of leveraged trading. If the balance in your account falls to a level that is below the minimum regulatory margin requirement, a margin call will be triggered. If this happens, we will message you to ask you to deposit more funds in your account to increase your account balance or close open positions to lift your margin above the minimum margin requirement.

What is a margin closeout?

If for any reason you don’t take either of the steps just described and your losses exceed your available margin, you will get a margin closeout. When this happens, OANDA will start closing all open positions for you till your margin is restored to a tradable value, typically around 50%.

Please take note, in a fast moving market, there may be little time between warnings, or there may not be sufficient time to warn you at all. Be mindful of the “margin closeout percent” field in the account summary of the trading platform. The closer the margin closeout percent is to 100%, the closer you are to a margin closeout.

Although it may at first seem like a penalty, the margin call is essentially a warning that you need to temper your risk level and attend to losses that could get out of control. Ultimately, you are responsible for monitoring your account to prevent margin calls and margin closeouts from happening in the first place. By limiting your trade size and working with stop losses, you can better maintain sufficient margin in your account to support your open positions.

How to calculate margin

The margin needed to open each trade is derived from the leverage limit associated with the forex pair that you wish to trade. For example, if your leverage is 30:1, you would need a margin of 3.3% (1/30 x 100). That means, with a leverage of 30:1, you can open a $30 trade for each dollar available in your account.

How to calculate margin

Let’s look at a simple forex example. You’re thinking of opening a long position of 5,000 units of GBP/USD. As leverage is 30:1, the margin needed to open this position is 3.3% of 5,000 = $165.00.

If the instrument you are trading has a different base currency to your account currency, then your margin will be calculated in the base currency and converted to your account currency at the prevailing exchange rate.

Tips for avoiding margin calls

  • Check your positions regularly
  • Never leverage your entire account balance
  • Deposit additional funds into your account when your available margin becomes low
  • Reduce the margin requirement by closing some open positions
  • Close individual positions
  • Use a stop loss
  • Be mindful of gap ups and gap downs, with sudden hikes or drops in price, as these could trigger a margin call if you have neglected to use stop losses.

Placing your first leveraged trade

Everyone gets into trading to make a profit, but the thing you have to keep in mind is not to lose money. In other words, maintain good risk management at all times. So when you are preparing to open a new trade, you want to calculate not just where to exit if the trade goes in your favor, but also how much loss you can sensibly handle. So if you’re going long a currency pair, looking up the chart, don’t forget to look down, too, and vice versa if you take a short position.

Most professional traders advise using 1% to 2% of your funds on any one trade, 5% at most. But there is one other thing you should take into account when opening trades on leverage, namely, the number of trades you have running at any one time.

Let’s say you have three trades on and they’re in profit, and you have just enough funds available to open a fourth trade. Before you go ahead and press that button - buy or sell - consider the risk you are exposing yourself to.

If you decide to go ahead, it would be wise to move the stop loss to a breaking even point on, say, two out of those three trades you have running, just in case all four trades turn against you later in the day. It’s very easy to assume that, say, only two out of four trades will go against you. But this is where traders so often get caught out - all four could turn against you at the same time.

Remember, having leverage to work with means your losses can also build up at speed, so keep your trade sizes appropriate for the size of your capital, and stop yourself from taking too many trades at once, no matter how confident you are that they will come through for you.

Key points on leveraged trading

Margin

OANDA takes a form of security (or deposit) against any losses that you may incur when you trade, and this collateral is typically referred to as margin. The margin needed to open each trade is derived from the leverage limit associated with the instrument that you wish to trade.

Leverage

Leverage allows you to put down a fraction of the full value of your trade while your platform provider lends you the rest. This amplification of your exposure to the market is calculated by a ratio and, depending on your broker, can vary from 10:1 to 1000:1. If you used leverage of 10:1, for instance, and had a balance of $100, you could enter into a position that commanded a value of $1,000.

Margin requirement

In order to keep a position open, you are required to maintain a minimum amount of money in your account, this is known as the margin requirement. The margin requirement is 50% of the margin needed to open a trade.

Margin call and margin closeout

You are required to maintain sufficient funds on your account to cover the margin requirement. If the funds on your account falls below the margin requirement, you will be notified on your trading platform and by email with a margin call, advising you to add funds. If your positions continue to trigger a margin call, your positions will be closed, one at a time, until your margin is sufficient to support the remaining trades you have open. This is known as margin closeout.

Key takeaways

  • You can use leveraged trading to leverage the funds in your account to potentially generate larger profits than your initial investment
  • The downside of leveraged trading is that you can just as easily rack up significant losses if the market were to move against you
  • OANDA takes a form of security (or deposit) against any losses that you may incur when you trade. This collateral is typically referred to as margin
  • This margin is similar to a downpayment on a mortgage: since you now have leverage on your margin, you can open trades by putting down a fraction of the full value of your trade. Your broker is effectively lending you the rest
  • Leverage is described as a ratio or multiple. A leverage of 100:1 means that for every US$1 you have in your account, you can place a trade worth up to US$100. With a leverage of 30-1, for every US$1 you have in your account you can place a trade worth up to US$30 and so on
  • Professional traders recommend using 1% to 2% of your funds on any one trade, 5% at most.

Frequently asked questions

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What is position sizing in forex?

Position sizing is simply a way of determining how many units you should trade according to your desired level of risk. To help you calculate your risk for any forex trade, you can find a useful tool here. Just fill in the fields and the calculator will work out the position size of your trade for you.

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What is Net Asset Value (NAV)

The NAV represents the current value of your trading account including your unrealised profits or losses (P/L). The figure may constantly be changing because you may have one or more trades open.

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How to calculate your available funds

Your available funds are equal to that part of your account’s Net Asset Value that is not being used as margin requirement to maintain open positions. These funds are free to be used to open another position, transfer to another sub-account or withdraw. You can quickly find this figure in the ‘Margin Available’ field on the Account Summary section of your trading dashboard.

Let’s say your account balance is US$550 and your unrealised P/L is US$-45. Your account’s NAV is US$550 – US$45 = US$505. And let’s say you have two open positions with a cumulative margin requirement of US$300. Your margin available would be US$505 (NAV) – US$300 (margin requirement) = US$205. In this scenario, you would be able to open a new position if the margin needed to open that position was less than US$205.

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How to determine when a margin closeout may occur

If your Margin Closeout Value falls to less than half of your margin required, all open positions will be automatically closed using the current OANDA trading rates at the time of closing. If trading is unavailable for certain open positions at the time of the margin closeout, those positions will remain open and the platform will continue to monitor your margin requirements. When the markets reopen for the remaining open positions, another margin closeout may occur if your account remains under-margined.

The Margin Closeout Value is equal to your balance plus your unrealised P/L from all open positions, converted into the currency of the account, calculated using the current midpoint rates. This value is approximately equal to your NAV, but with slight deviations due to being calculated based on midpoint rates rather than bid/ask rates.

For example, let’s say you have one open long position in 10,000 units of USD/ZAR. You are trading this instrument with leverage of 20:1. The margin needed to open your position was 5% of US$10,000 = US$500. So, the margin required to maintain your open position is 0.5 (US$500) = US$250. When your account’s NAV falls to US$250 or below, you will get a margin closeout.

On the platform your ‘margin used’ bar will indicate how close you are to a margin closeout; when you hit 100% margin utilization, your account will trigger a margin closeout.