Newbie question about leverage and margin

Hopefully some more experienced traders can help this confused guy an answer in layman’s terms.

If I deposit $1000 with my forex broker and I’m leveraged 100:1, and if I lose that $1000 would that mean I owe my broker $100,000?

Thanks in advance for any advice. I’m completely brand new to this.

I’m not sure what your logic flow is here. If you lose $1000 you lose $1000. Period. Full stop.

unless something really bad happens with the broker you can not lose more than your initial investment. you deposit 1000$ you can only lose 1000$ (99.99% of the time) in the fine print they do say something could go wrong that would allow you to lose more than your initial investment but i’ve never heard of that happening and i personally wouldnt worry about it
maybe very quick eratic price movements idk really what could cause it

[B]Hi racerx,[/B]

100:1 is now the maximum allowable leverage at U.S. brokers who are members of the NFA (this basically means all large, reputable U.S. forex brokers). This means that if you actually tried to enter a position which is 100 times the size of your account, you would immediately be margin-called.

[B]But, let’s walk through it, step by step, in order to illustrate how leverage and margin work:[/B]

[ul]
[li]You open an account with $1,000.
[/li]

[li]Your broker offers you leverage [B]up to[/B] 100:1 (this corresponds to a margin requirement of 1% of your position size).
[/li]

[li]you decide to go “all in”, and use the entire 100:1.
[/li]

[li]You place an order to buy 10 mini-lots of USD/CAD ($100,000 worth of currency — 100 times the equity in your account).
[/li]

[li]As soon as your order is received at the broker’s server, you will receive a margin-call and your order will be rejected.
[/li]Here’s why: when your order is placed, your account equity must cover two “expenses”: margin and spread. Margin in this case is $1,000 (1% of the position size you tried to put on), leaving no equity to cover the spread.

[li]After your order has been rejected, your $1,000 margin will be returned to you. Whether you are then charged with the cost of the spread will depend on your broker’s policies and procedures.
[/li]

[li]“All in” is obviously a special case: your position was never entered.
[/li][/ul]

[B]Let’s consider a trade where your position size is more reasonable, again step by step.[/B]

[ul]
[li]You open an account with $1,000.
[/li]

[li]As before, maximum allowable leverage = 100:1, and margin = 1% of position size.
[/li]

[li]You place an order to buy 1 mini-lot of USD/CAD ($10,000 worth of currency — 10 times the equity in your account).
[/li]

[li]For whatever reason, you do not place a protective stop on your trade.
[/li]

[li]Upon receipt of your order, your broker’s server sets aside $100 of your account equity for margin, and charges your account a spread. Let’s say that your broker’s spread on the USD/CAD is 3 pips, and the current pip-value is $0.95 per pip per mini-lot. That means that your broker charges your account $2.85 for the spread (3 pips x $0.95 x 1 mini-lot).
[/li]

[li]Your account equity is now $897.15 (that is, $1,000 - $100 margin - $2.85 spread).
[/li]

[li]Some catastrophe in the U.S. causes the USD/CAD price to plunge 1,000 pips (recall that you have no stop-loss in place).
[/li]

[li]Before the price finds a bottom (1,000 pips below your buy price), your losses will have consumed all of your $897.15 account equity, and your broker will automatically close your position (if you had more than one position open, the broker would close all of them).
[/li]

[li]After this margin-call, your $100 margin would be returned to you, and this would be the only money remaining in your account.
[/li]

[li]You have just lost $900 of your account ($2.85 for the spread + 897.15 in losses).
[/li]

[li]You did not lose $10,000 (the value of your position). And you don’t owe your broker any money.
[/li][/ul]

I hope that makes leverage and margin clear to you.

Clint

My first inclination was to say this isn’t true, at least not for all brokers. I believe FXCM actually does margin call when you drop below the initial margin requirement level, but most brokers I’ve seen have a “maintenance margin” which is lower - like half the original margin. Oanda, for example, falls into that category (though they don’t offer 100:1 leverage to begin with). In other words, check your broker’s policy.

That said, I’m wondering if the NFA rule applies to maintenance margin or just initial margin. I don’t recall seeing anything specifically about that, though I’ll admit to not paying close attention to broker notes on the subject as I never get anywhere close to full leverage. Anyone else?

Thanks for the reply Clint and everybody. Most of the terminology I’m still trying to learn. At first I thought that trading on margin with a 1k or 10k lot meant that you were actually controlling $10,000 worth of currency with a fraction of the investment. I haven’t traded with real currency or a real account but I just wanted to know that you can’t lose more than your initial investment. Thanks everybody.

racerx,

[B]That’s exactly what it means. [/B]

In the second example that I gave you, a $1,000 account [B]“controls” $10,000 worth of currency.[/B]

Clint

There is a BabyPips section on leverage that I recommend studying. Getting your head around the concept of leverage as it is applied in FOREX will help a lot.

Leverage: Forex Currency Trading Leverage Defined

Basically leverage is the size of your overall position (lots) relative to your account equity.

So, if you have a $10,000 mini account and you have a one mini lot position ($10,000), you are leveraged 1:1. Obviously if your equity changes with fluctuations of the market, or you add to or subtract position size, your leverage will change as well to reflect that.

Leverage = Position size:Equity

For example if your position grows by $1,000 because you made lots of pips (1,000 to be exact), your account equity is now $11,000. Because your position size did not change (1 mini lot = $10,000) Your leverage will now be 0.9:1.

10,000:11,000 = 0.9:1

If you lose the same $1,000 (1,000 pips) your account equity is now $9,000, and your leverage is now 1.1:1

10,000:9,000 = 1.1:1

Margin on the other hand is simply the amount of your account that is held by your broker when you enter a position.

It used to be very strait forward, now it is not since the new NFA rules came into affect:

The new 1% margin requirement is calculated by taking the Notional value of the base currency and converting it to USD. The base currency is defined as the first currency listed in the pair. For example a standard lot for the EUR/USD at a price of 1.5100 would have a notional value of 151,000 USD. Your margin requirement would be 1,510 or 1%.

For example:
Lot Size Standard Mini Micro Nano
1.00 $1,508.90 $150.89 $15.09 $1.51

If any of the above is incorrect, please feel free to correct me. I will not be offended! Thanks.

If you’re in a trade your account equity cannot change without the position size also changing. Thus, if you have $10,000 in your account and a $10,000 position on (1:1 leverage) and make $1000 the value of your account rises to $11,000 at the same time as the value of your position rises to $11,000. No change in leverage.

If I started with a 10,000 account, and I leveraged a 200K postion, and the account grew by 10,000, I would then have a 210K position? That would change my leverage from 20:1 to about 10:1 would it not?

210,000:20,000 = 10.5:1

Well, it depends on your position. For example, if you are long $200k USD/JPY a $10,000 gain in your equity could only come from a $10,000 gain in the value of your position. That being the case, your figures are correct.

If, however, the $10,000 equity gain is on a short it means the position is actually worth $190k. That would put the leverage at 9.5:1