[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