Trading With Leverage: The Ultimate Beginners' Guide

Introduction to leverage

What is leverage in trading?

Leverage allows you to open a larger position than your account balance would normally allow. It's expressed as a ratio, such as 1:100 or even 1:500 in the case of FPMarkets.com. For example, a leverage ratio of 1:500 means you can control $500,000 worth of assets with a $1,000 deposit.

In practice, leverage means you only need to put down a small percentage of each trade's total value - known as the margin - as your broker lends you the rest. Traders use leverage to boost their returns, but leverage can just as easily deepen losses.

What's the difference between leverage and margin?

Margin is the amount of money you must deposit to open and maintain a leveraged position. It also acts as security for the funds your broker lends you. The required margin depends on your account's leverage ratio. Here's how these concepts are related:

This margin requirement is called initial margin (i.e., the amount needed to open a trade). Once the position is open, it becomes part of your account's used margin (i.e., the portion of your account that is tied to a leveraged position). Your account's free margin, calculated as equity minus used margin, is the capital available to open new trades, or cover any unrealised losses.

Leveraged trading example

Let's say you open a $10,000 position on EUR/USD with 1:100 leverage. You only need to commit 1% of that amount as your initial margin, or just $100. This $100 becomes your used margin for as long as the trade is open.

Scenario A: The market moves in your favour

If EUR/USD rises by 1%, your $10,000 position will increase in value by $100, doubling your initial margin. Your used margin remains $100, but your account's equity, calculated as its balance plus unrealised profits, has risen to $1,100.

You can either close the position and realise the $100 profit, crystallising a 100% return on your investment, or keep it open and move your stop-loss higher.

Scenario B: The market moves against you

If EUR/USD falls by 2%, your $10,000 position will lose $200 in value. Your account's equity will fall by the same amount, from $1,000 to $800, all else equal.

Your account's maintenance margin is the minimum level of equity that you must maintain to avoid a margin call. It's often set to 50% of your used margin. As your $800 equity far exceeds 50% of your used margin, just $50, no margin call will happen.

A margin call is a requirement to deposit additional funds or close some positions to prevent your account from becoming negative. If you fail to act, your broker will automatically liquidate all or part of your trade. This process is known as a stop-out.

Leverage available in your country

The amount of leverage available to you depends on where you live and which regulator oversees your broker. Retail traders in the UK and the EU are limited to a maximum of 1:30 on major Forex pairs and 1:20 on minors, gold, and major indices. In the United States, the limit is typically 1:50 for major Forex pairs.

Some offshore brokers offer up to 1:500 or even higher. However, these accounts may not provide the same investor protections as regulated brokers in your country. Always check that any broker you trade with is properly licensed and regulated.

What's the best leverage for you

The "right" leverage ratio depends on your trading style, risk tolerance, and experience. Short-term traders or scalpers often use higher leverage to take advantage of small intraday moves. Longer-term traders typically prefer lower leverage to withstand market swings.

If you are new to trading, start conservatively, setting leverage as low as 1:2, until you understand how it affects your profit and loss. Most brokers allow you to set leverage at your account's level, so you can scale up gradually as your experience grows.

Best practices for leverage trading

Leverage should enhance your trading plan, not replace it. Here are a few ways in which you could make leverage work for you, rather than against you:

• "No single holding should represent more than 10% of your portfolio" according to Benjamin Graham, Buffet's mentor.
• Set stop-loss and take-profit levels before entering any position. This will help in other ways, by encouraging you to think about positive and negative scenarios.
• Use leverage tactically once you've identified a trading opportunity with a strong risk-reward ratio. Revert to lower leverage, no leverage, or simply a cash position otherwise.
• Consider reducing your account's leverage in the run-up to high-volatility events like central bank announcements, or even corporate announcements if you trade stocks.
• Review your positions during volatile market conditions, as stop-loss orders can fail when the price gaps either above or below your stop-loss order.
• Understand how your broker calculates margin requirements and stop-out levels. Most brokers set these limits at the account-level.
• If you are new to trading on margin, use a demo account to build your skills before trading with real money. Compare demo accounts on the MT4 platform.

FAQs about trading on leverage

Can I lose more than I deposit?

Most brokers, including offshore brokers, offer negative balance protection, which means that you cannot lose more than your initial deposit.

Is leverage trading legal?

Yes, leverage trading is legal in most countries, but local regulators in most developed markets impose limits to protect retail investors.

Does leverage affect spreads or commissions?

Leverage itself doesn't change the spread or commission, but highly leveraged positions tend to incur higher fees as they are larger in size. In addition, you may be liable for swap fees.

How does leverage affect swap fees?

A swap fee applies when you keep a position open overnight, defined as 5 PM New York time. The fee will be based on the full notional value of your position, rather than the borrowed amount, or its used margin.

Importantly, you don't always pay swap charges. In fact, you could earn swap charges when the interest rate of the currency (or asset) you're buying is higher than the one you're selling.

For example, you'll receive a positive swap if you go long USD/JPY, and the U.S. Federal Reverse's rate is higher than the Bank of Japan's. Trade Forex with up to 1:500 leverage through FPMarkets.com.

Do demo accounts use leverage?

Yes. Most demo accounts simulate live trading conditions, including leverage settings, so you can practise safely without risking real capital.

How to trade without leverage?

Set your account's leverage to 1:1 to trade without leverage. Most brokers allow you to set and adjust this setting at the account level.

Conclusion

Trading on margin can be both rewarding and risky. Use leverage tactically to generate outsized returns across trading opportunities with high-reward ratios. Understand how leverage works, and use strict risk management techniques to protect your capital from severe losses.

Leveraged trading involves significant risk and may not be suitable for all investors. Consider seeking independent advice before trading leveraged products.

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