Leverage and margin

Traders are commonly confronted with the option to use leverage and margin with their trades. These terms are intertwined because you use your margin to create leverage — one leads to the other. Margin means that your broker is lending you money to open positions that are several times larger than what would otherwise be possible with your available trading capital. The collateral for the loan is the cash in your margin account, and when trading on a larger timeframe, you can expect to pay interest on this loan. Short-term traders are often in positions very briefly, and therefore are less concerned with margin interest.

Trading With Leverage

Those with a margin trading account — which must be obtained via special application — can create leverage for their trades. Leverage multiplies your buying power by allowing you to pay less to open a position, making it possible to command much larger positions with a comparatively small amount of capital. With 2:1 leverage, for example, you’re able to buy CFDs at half price, meaning that you can also open a position that is valued at double the amount of funds deposited in your account. It works this way no matter how much leverage you’re using.

If you’re trading with 100:1 leverage and have $1,000 in your trading account, then you’d be able to open a position worth $100,000. Note that you do not need to open a position with all your trading capital. If a stock is trading at $100 for one share, using 100:1 leverage means that you can buy one share for just $1.00. With $1,000 and 100:1 leverage, you’d be able to open a position of 1,000 shares in the company. Always be aware that leverage has the potential to magnify your profits or losses.

If the price of the stock increases to $115, your position is worth $115,000. When you close the position, you’re returning the $100,000 to your broker, and get to keep $15,000. If you had invested without leverage, you’d have only generated $150. On the other hand if the price of the stock decreases to $85, your position is worth $85.000. When you close the position you return the 100,000 to the broker and you suffer the losses of $15,000

The Margin Call

While margin trading can magnify potential returns, trading with leverage also comes with increased risks. Brokers employ what’s known as a ‘margin call’ to alarm traders that their account has depreciated to a value calculated by Investous’s particular formula. Trades with leverage that move in the wrong direction can multiply quickly and drain your available trading capital much more rapidly.

If leveraged trading positions deplete available trading capital past a certain threshold, the platform will alert an investor about their account balance. At this point, you’ll be margin called and prompted to deposit more money to keep the position open. If you don’t satisfy the margin call with a deposit, the position will be automatically closed to prevent the account from sinking into a negative balance.