What is Leverage, Margin & Hedging?

Margin is collateral that an investor has
to deposit with their broker or an
exchange to cover the credit risk the
holder poses for the broker or the
exchange.

Hedging in the forex market is the
process of protecting a position in a
currency pair from the risk of losses.

Leverage is an investment where
borrowed money or debt is used to
maximize the returns of an investment,
acquire additional assets or raise funds
for the company.

Individuals or businesses create debt by
borrowing money or capital from
lenders and promising to pay this debt
off with the added interest. Thus,
leverage can also mean trading equities.

Leverage is the ability to control a large
amount of money using none or very little
of your own money and borrowing the rest.

Leverage works by using a deposit, known
as margin, to provide you with increased
exposure to an underlying asset.
Essentially, you’re putting down a fraction
of the full value of your trade – and your
provider is loaning you the rest. Your total
exposure compared to your margin is
known as the leverage ratio.

For Example: to control a $100,000
position, your broker will set aside $1,000
from your account. Your leverage, which is
expressed in ratios, you would have a 100:1
margin (and 100x leverage). You’re now
controlling $100,000 with only $1,000.

Buy 1 lot EUR/USD at Price 1.23000 with
unit basic is 100,000.

Without Leverage you may need:

Margin Requirements = 1 lot x 1.23000 x
100,000 = 123,000 USD.

So, you have to prepare the Margin at
123,000 USD for open 1 lot only at
EUR/USD.

With Leverage, the conditions are
different if the broker provides
Leverage 100:1.

Margin Requirements = 1 lot x 1.23000 x
100,000 = 123,000 USD / 100 = 1,230 USD

From borrowing from the broker, you only
need to have 1,230 USD to open 1 lot at
EUR/USD.

There are two related strategies when
talking about Hedging Forex Pairs:

The first strategy is creating a “hedge”
to fully protect an existing position from
an undesirable move in the currency pair
by holding both a short and a long
position simultaneously on the same
currency pair – for instance, if the
investor holds EUR/USD long, they short
the same amount of EUR/USD.

The second strategy is creating a
“hedge” to partially protect an existing
position from an undesirable move in
the currency pair using Forex options,
such as buying puts if the investor is
holding a long position in a currency.

Forex hedging is a type of short-term
protection and, when using options, can
offer only limited protection.

Margin is a trading system that uses
collateral in transaction or loan capital and
can be interpreted as collateral that is held
during your transaction.

Margin trading gives you the ability to enter
into positions larger than your account
balance.

With this Margin, in futures trading we can
make a sell position first without having to
buy at the beginning.

This is what makes the difference from
traditional stock trading, where one cannot
make a sell position before buying.

Margin Requirement is the amount of
margin required to open a position. It is
expressed as a percentage (%) of the “full
position” size or “Notional Value” of the
position you wish to open. Depending on
the currency pair and Forex broker, the
amount of margin required to open a
position varies.

Required Margin is the amount of
money that is set aside and “locked up”
when you open a position.

Let’s say you’ve deposited $1,000 in your
account and want to go long GBP/USD at
1.30000 and want to open 1 mini lot (10,000
units) position.

Since GBP is the base currency, this mini lot
is 10,000 pounds, which means the
position’s Notional Value is $13,000.

Assuming your trading account is
denominated in USD, since the Margin
Requirement is 5%, the Required Margin
will be $650.

A margin call is a notification from a broker
to notify a trader that the Margin Level has
fallen below the required minimum level.

The Margin Call occurs when the floating
losses are greater than the Used Margin.

• You have to be aware of Margin Call
  Notification from the Broker.
• Understand and manage the Margin
  Requirements before placing any
  order.

• Use stop loss orders to avoid Margin
  Calls.
• Scale in positions rather than entering
  all at once. (instead of trading with 4
  mini lots right off the bat, start off with
  1 mini lot, then add or “scale in” to the
  position as the price moves in your
  favor.

Used Margin is all the margin that’s
“locked up” and can’t be used to open
new positions. Simply said, this is the
total amount of margin currently in use
to maintain all open positions. Said
differently, it is the SUM of all Required
Margin being used.

Free Margin is the money that is NOT
“locked up” due to an open position and
can be used to open new positions.
When Free Margin is at zero or less,
additional positions cannot be opened.

“Equity” represents the current value of
your trading account and continuously
fluctuates with the current market prices as
long as you have any open positions. As
your current trades rise or fall in value, so
does your Equity.

Equity shows the “TEMPORARY” value of
your account at the current time. That’s why
Equity is seen as a “floating account
balance“. It will only become your “real
account balance” if you were to close all your
trades immediately.

The Balance reflects the profit/loss only
from closed positions while the Equity
reflects the real-time calculation of your
profit/loss. The Equity takes into account
both open AND closed positions.

The open positions and margin (collateral)
are not included in the balance.

If your account is “flat” or does NOT have
any positions open, then your Balance
and Equity is the SAME.

If you do have open positions, this is
when the Balance and Equity differ.

You deposit $1,000 in your trading
account. Since you haven’t opened any
trades yet, your Balance and Equity is the
same.

Price moves immediately against you
and your trade show a floating loss of
$50. The Equity in your account is now
$950.

Price moves immediately in your favor
and your trade show a floating gain of
$100. The Equity in your account is now
$1,100.

Since Equity includes current profits or
losses from open trades, it is Equity that
shows the real-time amount of your
funds.

It’s possible to have a very large Balance,
but very small Equity. This happens when
your open positions have largely
unrealized (floating) losses.