Learning Some Very Important Terms in Forex Trading Is a Must before Risking Any Money: Leverage, Margin, Balance, Equity, Free Margin, Margin Call and Stop out Level

 Many traders who trade forex, commodities and indices do not know what margin, leverage, balance, equity, free margin and margin level are,  how to manage them, and  knowing  how to calculate the size of their positions.

Margin and leverage are two important terms that are usually hard for many traders to understand.  In order to understand what margin is in Forex trading, first we have to know the leverage.



What Is Leverage?

“Leverage” is a feature offered by the brokers.

It is like a special offer indeed.

It helps the traders to trade the larger amounts of securities through having a smaller account balance.

For example, when your account leverage is 100:1, you can buy $100 by paying $1.

Therefore, to buy $100,000 (one lot), you should pay only $1000. This is an example to understand what leverage means.

For Example:

If you are trading at 10 lots USD through an account that its leverage is 50:1, you have to pay $20,000 to buy 10 lots or $1,000,000 USD:

                            $1,000,000 / 50 = $20,000

This is all about Leverage, it is always important to choose lower leverage with big amount of capital for proper money management trading. The example above shows 20% of leverage.

Margin

Margin is calculated based on the leverage.  “Required Margin” is the amount of the money that gets involved in a position or trade as collateral.  Let’s say you have a $10,000 account and you want to buy €1,000 against USD.

How much US dollars do you have to pay to buy €1,000?

Let’s assume that the EUR/USD rate is 1.4314.

It means each Euro equals $1.4314.

Therefore, to buy €1,000, you have to pay $1,431.40:

€1,000 = 1000 x $1.4314

Therefore:

€1,000 = $1,431.4 ( Your current price)

If you take a 1000 EUR/USD long position (you buy €1000 against USD), at price of $1,431.4 from your $10,000 account has to be locked in this position.

When you set the volume to 0.01 lot (1000 unit) and then you click on the buy button, $1,431.4 from your account will be paid to buy 1000 Euro against USD.

This “locked money” which is $1,431.4 in this example, is called Required Margin.

Close Your Position

Now, if you close your EUR/USD position, this $1,431.4 will be released and will be back to your account balance.

Now let’s assume that your account has a 100:1 leverage.

To buy 1000 Euro against USD, you have to pay 1/100 or 0.01 of the money that you had to pay when your account was not leveraged.

Therefore, to buy 1000 Euro against USD, you have to pay $14.31:

$1,431.4 / 100 = $14.31