Confused about "size", lot, leverage, margin,etc. Here is my specific question please

I have read quite a bit about the above terms including in the Pip school. I am keen to do Forex trading and have opened a demo account and done over 20 trades conservatively (I think) increasing my account from $1,000 to $1,035 in 3 weeks. But I am still quite confused and unclear about the above terms and it does my head in.

Here is an example I read online. I will copy that here and give you my interpretation of it. Please let me know if my understanding is correct. Sorry for my confusion/ignorance.

(a) “Leverage ratios are commonly in the range of 100:1 to 10:1. If the ratio is 100:1, the trader must reserve 1% of the trade value as margin.”

[The leverage in my account is is 200:1.
Does this mean that I must reserve 1/200=0.5% of my trade value of my deposit of $1000=$5 as margin for this trade?

For the next trade, does it mean that the amount to reserve should be 0.5% of $(1000-$5)=(0.5/100)x$995=$4.97?]

(b)“For example, consider the trader who enters a full size trade for USD/JPY. That trade has a value of $100,000 US Dollars. If the leverage offered by the broker is 50:1, the trader must maintain and commit 2% of the trade value in his margin account, or $2,000.”

[My deposit is $1,000. That is a micro lot as I understand it. The leverage is 200:1. So basically this is the same question as (a) and means I should maintain and commit 0.5% x$1,000=$5?]


© If the USD/JPY trade gains in value, the trader’s account balance will increase by the amount of the profit (thus providing additional funds that the trader might use to enter additional trades).

However, if the trade loses funds, even temporarily, the trader must commit additional margin funds to the trade, thus reducing the amount in the margin account that would otherwise be available to commit to other trades."

[Can you please give me a quick example to make this clear to me please?]


(d) On the MT4 platform, while entering a trade, it asks us to enter “VOLUME” with choices such as 0.01, 0.02 etc. What does this refer to? The lot “size” or the individual trade size?


Thank you. Sorry for too many questions and my ignorance. I am a bit slow to understand stuff. Cheers.

Hello again, Clem

Answers to your questions:

B[/B] Margin applies to the size of your position, not the size of your account balance.

If you trade 0.01 lot of EUR/USD (as an example), then the value of your trade is 1,000 units of EUR x the EUR/USD exchange rate. Currently, that would be: 1,000 x 1.12702 which equals $1,127.02 That’s the USD value of your 1,000 units of EUR/USD.

If your maximum allowable leverage is 200:1, this corresponds to ½ of 1% margin applied to each trade.

In the EUR/USD trade in the example above, ½ of 1% of $1,127.02 = 0.005 x $1,127.02 = $5.64

If you place a second trade (in the same pair or in a different pair), the ½ of 1% margin percentage will be applied to the USD-value of that second trade, in the same fashion as described above.

These margin calculations have nothing to do with the balance in your account.

B[/B] Your deposit has nothing to do with margin calculations. And, furthermore, deposit amounts are not quoted in terms of lots.

The position size in the USD/JPY example is 100,000 units, with a USD-value of $100,000. That’s the position size on which margin is calculated.

½ of 1% of $100,000 = 0.005 x $100,000 = $500. That’s the margin required for this 1-lot position in USD/JPY.

(And, by the way, that position size is WAY too large for your $1,000 account – but, your account balance had nothing to do with determining the required margin for this trade.)

B[/B] Let’s say you actually placed that 1-lot USD/JPY trade in your $1,000 account. As soon as you enter the trade, your broker will “set aside” $500 of [I]your money[/I] to cover the required margin, which we calculated above.

After this “set aside”, you have only $500 remaining in your account to work with (meaning to cover losses, to open another position, to withdraw, etc.). The terminology used by most brokers in this scenario is that you have $500 in USED margin, and $500 in FREE margin.

Suppose the USD/JPY price moves 50 pips against you. And suppose that the pip-value for this pair and this size position is $8.99 per pip.

Your 50-pip loss has a USD-value of 50 x $8.99 = $449.50

This dollar-loss is subtracted from the $500 you had left to work with, meaning that you have lost almost all of your FREE margin.

As a practical matter, most brokers would close your position (involuntarily) before your FREE margin got this close to ZERO.

Let’s say that your position is closed as soon as your loss reaches 50 pips ($449.50). At that point, you have $50.50 of FREE margin remaining. Your broker now releases your $500 USED margin back to you.

At this point, your account balance has been reduced to $550.50, and you have no open positions.

B[/B] It refers to the size of a particular position. (Lot size and individual trade size are the same thing.)

In the EUR/USD example, the lot size was 0.01 (1 micro-lot, which means 1,000 units of EUR/USD).

In the USD/JPY example, the lot size was 1.0 (1 standard lot, which means 100,000 units of USD/JPY).

I hope that clears things up for you.

.

Clint, thank you very much. I appreciate your patience, time and effort. I feel I am getting this. Will read your replies again carefully and clear my cobwebs.

I do have another question:

As I understand it, when entering a Buy limit/pending long order, we need to enter a value below the current ask price and for a Sell limit/pending short order, we need to enter a value above the current bid value.

I need to know if there is a solution to this dilemma for me.:

Say I want to set up a trade to get executed automatically a little later when I am away from the computer.

Say the current price of EUR/USD is 1.11485
I wish to enter a buy order at 1. 11500, which is above the current price.

How do I set this up for automatic execution when the price hits 1.11500?

[B][I]Does a BUY STOP order achieve this?[/I][/B]

Hi, Clem

• Yes, you would enter a BUY STOP order at 1.1150, which would be a pending order, until your broker’s ASK price reached 1.1150, at which time your BUY STOP order would be filled as a market order.

• If you wanted to add a stop-loss order to protect this position, you would enter a contingent SELL STOP order at (say) 1.1140. This order would be contingent on your BUY STOP order to enter being filled first.

If your BUY STOP order to enter is not filled, then this contingent SELL STOP order will not be filled, even if the BID price falls to, or below, 1.1140.

Different brokers have different ways of handling these contingent orders, and use different terminology to describe them. Familiarize yourself with your broker’s order-handling protocol, and his terminology.

• If you wanted to add a take-profit order to this position, you would enter a SELL LIMIT order at (say) 1.1160. This order would also be contingent on your BUY STOP order to enter being filled first.

In your question, you say that the current price is 1.11485. Is that the BID price or the ASK price?

Most traders watch BID prices on their charts, and keep in the back of their minds that ASK prices are higher by the amount of the spread.

If that “current price” is your broker’s BID price, and if the spread on EUR/USD is 1 pip, then you are proposing to place a BUY STOP order just 0.5 pip above the current market.

On the other hand, if that “current price” is your broker’s ASK price, and the spread is 1 pip, then your BUY STOP order will be 1.5 pips above the current market.

In either case, your BUY STOP order is very close to the current market.

You should always be aware of:

(1) which price series (BID or ASK) you are watching on your charts,

(2) which price series applies to the order you want to place –

– you ALWAYS buy at the ASK price and sell at the BID price, and

(3) how close to the current market your broker WILL ALLOW you to place pending orders.

Here is a table I made several years ago to show the various order types, and how they are used.

You might find it to be useful.

Thanks to Clint for that… Some brokers do not have this rather cumbersome labelling and a buy or sell order are just that, regardless of whether they are above or below current price… It seems more logical that way… Also, some brokers use the word ‘volume’ for position size, hence the confusion here…

Thank you Clint. I really appreciate your help. It is amazing. Cheers!