Margin trading is the leverage that is provided by a broker. It provides for the possibility for traders to open transactions for a total amount of several tens, hundreds, thousands of times greater than the total amount of the trader’s deposit, provided that this money is returned.
Each broker has a leverage of 1: 1 (that is, its absence), 1:10 (a trader can open transactions with a volume 10 times the deposit), 1: 100, and even 1: 2000. According to the recommendations of European regulators, earlier the maximum allowable limit of leverage was 1: 200, now – 1:50 with the prospect of a decrease to 1:30. True, these restrictions do not stop brokers with offshore registration and therefore leverage up to 1: 1000 or 1: 2000 continues to be met.
Where the broker gets the so-called loan money, none of the company representatives will answer you, citing trade secrets. There may be several options:
- Assistance to liquidity providers. Liquidity providers are investment banks whose liquidity is confirmed by deposits of depositors, due to which the trader’s deposit can increase. True, there is a question as to what liquidity providers earn. Maybe brokers share the spread. If this option were obvious, brokers would not hide it, but the mechanism for providing leverage was not disclosed.
- Technical animator. Whatever leverage is presented, trading is still conducted within the trader’s deposit. A trader buying a currency sooner or later sells it back, restoring balance. The leverage of the broker is just a digital instrument, offset by a reverse transaction. The total volume of transactions with such digital instruments is many times greater than the amount of real currency. But the system maintains balance since each trade in one direction will one way or another be followed by a trade in the opposite direction. The profit of one trader is the loss of others.
- The broker is a kitchen. Numbers are manipulated within the company itself. The broker’s goal is to offer the trader as much leverage as possible so that he loses the deposit as quickly as possible.
In theory, it is often written that margin trading is “a virtual loan secured by a trader’s deposit” or “bilateral transaction, where a trader who buys an asset for credit money will then be required to sell it.” Actually, this is not true. In any credit transaction, the lender also bears the risk of default on the loan. In margin trading, the broker does not bear these risks.
- Without leverage. The trader has $ 1,000, of which $ 600 he wants to invest in oil. Oil volatility is small – 0.1-0.3% per day. Suppose that a trader conducts intraday trading and force majeure occurs on the oil market, as a result of which oil is immediately cheaper by 5%, that is, from 60 to 57 US dollars per barrel. If a trader had opened a long position at his 600 US dollars, his losses would have been 600 * 0.05 = 30 US dollars. For a deposit of $ 1,000, the amount is small.
- With leverage. Suppose that a trader is confident in rising oil prices and decides to take advantage of the leverage of 1: 1000. Its principal amount of $ 600 is blocked by the broker as collateral, while the remaining $ 400 of available funds will serve as insurance. Total, the investor opens a position in the amount of 600 * 100 = 60,000 US dollars. Force majeure crosses out investor plans and a loss of $ 30 turns into $ 3,000. A trader does not have that kind of money, because his transactions will be closed forcibly even before the oil price drops to $ 57. It is easy to calculate that a security deposit of $ 600 is able to withstand with such a shoulder only 1% of the price drawdown (60 cents), the remaining funds ($ 400) – another 40 cents.
Margin Call is a situation in which, if the amount drops below a specified level, the broker informs the trader about the need to replenish the deposit. This is a kind of warning that, given the current trend, the trader’s deposit will soon be reset.
Stop Out (Stop Out) – forced closure of the trader’s transactions at the current market price in the case when the ratio of the deposit amount and the current loss to the amount reserved for the current open collateral (level of funds) is lower than that established by the broker. Closing of transactions takes place alternately until the account level exceeds the established limit.
The broker sets the margin call parameter on Forex – 20%, stops out – 10%. The trader replenishes the deposit for $ 300 and uses a leverage of 1: 100, opening a deal in the amount of $ 20,000. The amount of equity required to open such a transaction is 1/100 of 20,000, that is, $ 200. 20% of the amount of the pledge – 40 US dollars, 10% – 20 US dollars. This means: when the trader’s loss is $ 260, a warning will follow when the trader’s account drops to $ 20, the forced closure of transactions will begin.
The example is conditional, as it provides for a simplified market situation. A more detailed calculation of the stop out level in Excel will be given below.
Important! European regulators, setting limits on the maximum leverage, are fighting not with brokers, but with the psychology of traders. The amount of leverage on Forex carries no risk. After all, there is no difference whether a trader opens a transaction with a leverage of 1: 100 (pledge – $ 200) or leverage of 1: 200 (pledge – $ 100) when depositing $ 300. He will still trade within the framework of his deposit of $ 300. The value is the volume of the position! If in this case it is targeted ($ 20,000), then in practice, emotions push traders to open larger deals with greater leverage, which can lead to losses.
In MT4, data on available funds and account levels are indicated in the lower menu in the “Trade” tab.
- Balance. The amount of deposit that the trader has made to the account.
- Facilities. The current deposit balance after transactions. Equal to the amount of the balance adjusted for current profit or loss. If the amount of loss on open losing trades exceeds the profit on profitable ones, in this column the figure will be less than the Balance by the amount of loss. For example, $ 100 was paid, in one of the 2 transactions a profit of $ 32, in the second – a loss of $ 43. 100 + 32-43 = 89.
- Margin (More commonly used is the definition of “Collateral”). The size of the collateral for open transactions, which the broker blocks from the balance sheet of the trader. If a trader buys Euros in the amount of $ 10,000 with a leverage of 1: 100, the security deposit will be $ 100.
- Free margin. Money that is not involved in trading and can be used at the discretion of the trader. It is calculated as “Means” – “Margin”.
- Level. The indicator of the state of the account, measured in percent. The main landmark of the trader. If its value drops below the stop out established by the broker, the closing of transactions will begin. It is calculated by the formula: “Funds” / “Margin” * 100%.
The trader replenishes the account with $ 100 and is going to conclude a deal in the amount of 0.01 lots at a price of 1.4500 with a leverage of 1: 100. 1 lot is 100,000 units of conventional currency, therefore, for the purchase of 0.01 lots, you need 14.5 US dollars (the volume of the entire position – 1 450 US dollars). “Balance” – $ 100. “Means” – before the start of transactions, also $ 100. Margin – $ 14.5. Free Margin – $ 85.5. “Level” – (100 / 14.5) * 100 = 689%.