What is Leverage?
Leverage is a loan given to the trader broker, so the fund traders have greater purchasing power. Leverage notified as a ratio, such as 1:1, 1:100, 1:500, and so on. That is, if there is funding $ 100 at 1:100 leverage the $ 100 has powers equivalent to $ 10,000. If leverage is 1:500, the fund had $ 100 has the ability to conduct transactions $ 50,000 or equivalent 500x larger than the nominal funds itself.
What is Margin?
Margin is an assurance given to the broker every time you open a position. The size of the margin is affected by the amount of leverage and trading volume (lot) which was opened by the trader. Margin calculation formula is: Leverage x Volume (Lot) x Contract Size.
Illustration
For ease of understanding, let us refer to the illustration below. Brokers are taken as an example is FXOpen, who has contract size 1 lot = $ 100,000 and up to 1:500 leverage facility.
Contract Size
For the contract size, should be converted to USD. Pair that start with USD / xxx as USD / JPY, USD / CHF, USD / CAD, etc. have a contract size 1 lot = $ 100,000 (already in the $, do not need to be converted). Meanwhile, beginning with the non-USD currencies, eg EUR / USD has a contract size of 1 lot = EUR 100,000, which means the equivalent of (EUR 100,000 x 1.435) or $ 143,500 USD at the exchange rate EUR / USD 1.435. Meaning, if the EUR / USD rose to 1.45 then the contract size will be changed again.
Leverage 1:1 – 1 lot of EUR / USD at price 1.4350
Margin required = (1/1) x 1 lot x (EUR 100,000 x 1.4350) = $ 143,500 – That is here, it takes a MINIMUM of funds (Free Margin) $ 143,500 to be able to open up the position of 1 lot of EUR / USD at 1:1 leverage
Leverage 1:100 – 1 lot of EUR / USD at price 1.4350
Margin required = (1/100) x 1 lot x (EUR 100,000 x 1.4350) = $ 1435 – That is here, it takes a MINIMUM of funds (Free Margin) $ 1435 to be able to open up the position of 1 lot of EUR / USD at leverage 1:100
Leverage 1:500 – 1 lot of EUR / USD at price 1.4350
Margin required = (1/500) x 1 lot x (EUR 100,000 x 1.4350) = $ 287 – That is here, it takes a MINIMUM of funds (Free Margin) $ 287 to be able to open up the position of 1 lot of EUR / USD at leverage 1:500
Leverage 1:500 – 0.1 lot of EUR / USD at price 1.4350
Margin required = (1/500) x 0.1 lot x (EUR 100,000 x 1.4350) = $ 28.7 – That is here, it takes funds (Free Margin) JUST $ 28.7 in order to open a position 0.1 lot EUR / USD at leverage 1:500
Leverage 1:500 – 1 lot of USD / JPY at any price (because the contract size is in USD)
Margin required = (1/500) x 1 lot x ($ 100,000) = $ 200 – That is here, it takes a Minimum of funds (Free Margin) $ 200 to be able to open up the position of 1 lot USD / JPY at leverage 1:500
Leverage 1:500 – 0.1 lot USD / JPY at any price (because the contract size is in USD)
Margin required = (1/500) x 0.1 lot x ($ 100,000) = $ 20 – That is here, it takes funds (Free Margin) ONLY $ 20 to be able to open up the position of 1 lot USD / JPY at leverage 1:500
Perception Errors
Often there is a misperception that the profit and loss, or the value per pip is different between 1:1 and 1:500. This view is not correct, we take the example FXOpen, 1 lot valued at $ 10/pip 1:1 1:500 was then in 1 lot will be worth $ 10/pip. What is different due to the amount of margin leverage only, thus affecting the amount of lots that could be opened up. Suppose you have $ 1,000 in the fund, it can open up to 1:500 in 5 lots of USD / JPY, while at 1:100 could only open 1 lot USD / JPY only.
Warning
Leverage benefits on the one hand, as it will provide greater benefits and allow us to play forex with a smaller capital. But on the other hand, with 1:500 leverage we could open position away from the ability of our funds. Therefore, it is wise to leverage and margin, due to losses suffered could be greater than our capacity, due to a lack of understanding of the risks of leverage and margin.