Leverage and margin are features in trading that allow traders to control larger market positions with smaller deposits. Understanding how these processes work, including the risks and costs involved, is essential for anyone considering trading leveraged financial instruments.
Leverage and margin trading is used by those looking to increase the
Trading using leverage and margin magnifies the size of losses as well as gains, which means it is crucial to develop a clear understanding of what is involved before using them.
What Is Leverage?
Leverage is a trading tool which lets you open positions in financial instruments which are greater in size than the money you have in your account, increasing your potential market
Leverage amplifies gains and losses because profit and loss are based on full exposure, not the deposit amount.
Case Study – Leveraged trade in Tesla Motors
- A trader deposits $500 into their trading account.
- Using leverage of 1:4 they open a long $2,000 CFD position in Tesla Motors Inc (TSLA) stock.
- The price of TSLA stock falls by 4%.
- The trader closes the trade crystallising their loss of $2,000 x -4% = -$80.
- The traders cash balance is now $420.
Note how the amount of profit/loss on leveraged trades is applied to the total exposure not the initial deposit. The loss is therefore $80 ($2,000 x 4%) not $20 (500 x 4%).
These examples are simplified and for illustrative purposes only; actual liability depends on personal circumstances and local laws.
Leverage is fundamentally a multiplier that determines how much market exposure a trader can access relative to their deposit. These are some of the key characteristics of how it works:
- Leverage is expressed as a ratio. A 1:10 ratio reflects the overall exposure will be x10 the initial deposit.
- The maximum leverage available varies by instrument type and is often subject to regulatory limits.
- More volatile instruments typically have lower maximum leverage ratios to reflect their higher risk profile.
- These limits exist to help protect traders from excessive risk exposure but trading with leverage is still considered high risk.
- Leveraged products can produce larger gains or losses compared to unleveraged positions of the same initial investment size.
Traders using leverage can typically set the level of leverage they want to use at the time of opening a trade. Here’s how different leverage ratios affect exposure on the same deposit amount.
| Deposit | Leverage | Exposure |
|---|---|---|
| $100 | 1:2 | $200 |
| $100 | 1:5 | $500 |
| $100 | 1:10 | $1,000 |
What Is Margin?
Margin is the amount of money set aside to open and maintain a leveraged position – it acts as collateral and helps cover potential losses. In the example of a trader using $500 to open a leveraged position of $2,000, the $500 amount is the “margin”.
The key characteristics of margin are:
- Unlike leverage (which is a ratio), margin represents an actual monetary amount.
- The margin requirement is linked to the position size and amount of leverage used.
- The margin you place with the broker is what gives them the confidence to let you trade using leverage as brokers can extract any losses from your capital deposit.
Calculating margin gets more complicated when you also hold assets such as stocks, bonds and forex, and when you have profits or losses on open positions. Your broker might consider those positions as forms of collateral and incorporate them into the formulae they use to determine your overall margin level.
Key margin terminology
Terms which are commonly used when discussing margin and leverage are outlined in the table below. Developing an understanding of them can help traders monitor their account status and risk levels when using leverage.
| Term | Plain-English meaning |
|---|---|
| Leverage | The multiplier showing how much exposure you control relative to margin |
| Margin | The deposit required to open and maintain a leveraged position |
| Exposure | The full market value of your position (margin × leverage) |
| Margin requirement | The percentage of exposure needed as margin (e.g., 20% margin = 1:5 leverage) |
| Margin level | The ratio between account equity and used margin across all positions |
| Available margin | Funds available to open new positions after accounting for current positions |
How Does Leveraged Trading Work?
Leveraged trading uses margin deposits as collateral to allow traders to open positions which have greater market exposure than the size of their initial deposit. The way the process works in practice reflects the differences between trading with leverage and