What is leverage?
Leverage is a mechanism that allows a trader to control a position larger than the cash amount committed as margin. For example, leverage of 10:1 means that $1 of margin may provide exposure of up to $10, subject to the broker's rules and requirements.
Leverage increases exposure. It does not make a trade safer or improve the probability of success.
What is margin?
Margin is the amount of account funds required to open and maintain a leveraged position. Used margin is committed to open positions, while free margin is the amount available for additional positions or to absorb losses.
Margin level
Margin level is commonly calculated using account equity divided by used margin, multiplied by 100. Brokers may have different margin-call and stop-out requirements.
If losses reduce equity too much, the account may approach a margin call or forced liquidation threshold.
Overleveraging
Overleveraging occurs when a trader opens a position that is too large relative to account equity. Even a small market movement can then produce a large monetary gain or loss.
- Use position sizing before selecting leverage.
- Avoid risking a large part of the account.
- Monitor used margin and free margin.
- Understand your broker's margin rules.
- Be cautious during high-volatility events.