Earning more with leverage: margin, margin call and stop out, equity

In this lesson, you will learn:

• How to use leverage and earn 500 times more than with your regular investments
• What a margin is and why a margin call and stop out are not the things you’d like to experience
• How to calculate your equity and why it is so important.

During the last decade, there have been several major economic events that had a massive impact on the Forex market.  

For instance, a surprise move of the SNB in January 2015, which was later named ‘francogeddon’, caused the Swiss franc to soar by around 30 percent in value against the euro within minutes.

In October 2016, the pound sterling dropped 9% against the US dollar within seconds in overnight trading. The incident was described as a ‘flash crash’.

Such events allow traders to achieve large revenues in a short period of time.

But usually, currency quotes tend to change in a very small percentage.

To earn a tangible amount on Forex you might have to wait for a next major economic event and invest a huge amount of your personal funds and ignore all rules of risk management.

Luckily, there is a leverage that your broker is ready to offer you any time you open an order.

Leverage is a loan that multiplies your initial investment. Your broker provides you with it at the moment you open an order.

Leverage is expressed in ratios.

If the leverage is 1:2, it means that you can hold a position twice bigger than your initial investment.

The leverage 1:100 allows to open positions 100 bigger.

OctaFX offers a wide range of leverage: you can set it up to 1:500 depending on your skills and assets you’re trading.

Assume you have $2000 on your trading balance, and you wish to invest it in USDJPY without leverage.

That enables you to trade 2 micro lots of the pair. You open a buy order at the price 110.872 and hold the trade for about 37 hours until you close it at 112.482. During that time, the price has increased by 161 pips.

The price of a pip, in this case, is $0.18.

This way you have earned $28.98.

To gain a profit of 1.5% of your initial investment is reasonable for such a short time.

But let’s see what you can gain from this trade using 1:50 leverage.

Your $2,000 allow you to hold $100,000 of capital.  

That enables you to trade a full-size lot of USD/JPY.  

Each pip in the pair is now $9.09 worth.  If you make 161 pips, you earn $1463. You, therefore, increase your balance by 75%, lifting it to $3463. You can only achieve such an impressive outcome on the Forex market if you apply leverage.

However, do not forget about risks.

If you lose 161 pips in your USD/JPY trade, you lose $1463, and your balance drops to  $537.

Using high levels of leverage, you can quickly double your trading account balance, but you can equally fast run into the opposite result and reduce your trading funds to zero.

That is why you should not invest a substantial part of your balance into one trade no matter how much you could potentially earn.

In the trading world, you often hear that Leverage is a Double-Edged Sword.

Proper distribution of funds on your balance is called a risk management and you will learn about it in our next lessons.

To offer you a leverage, your broker needs to be sure that you are capable to cover a potential loss of the trade.

Margin is an amount of money on your trading account required for opening new positions and keeping initiated trades open.

Once you open an order, your broker will control the margin up until you close the order.

And if you lose you never risk the leverage you borrowed but you risk the margin.

Remember when we opened a 1-lot-size order with a 1:50 leverage, the margin equaled $2000, which was all the money we had on our balance.

Hence, we could not open new orders until we close this one.

But if we trade 1 mini lot ($10,000) with 1:50 leverage, then, to control trades of such volume, we will only need $200.

This way, we will be able to use the leftover of $1800 for further trading.

Leverage is expressed as a ratio (such as 1:50), and the margin is expressed in percentage terms:

• If you set the leverage at 1:50, the margin amounts to 2% of the order volume.
• While if you set the leverage at 1:100, the margin amounts to 1% of the order volume.

Like the leverage ratios, margin requirements vary depending on different currency pairs.

Let’s assume, you decided to trade mini and micro lots and opened many orders.

Good: some of them seem to go in your favor, and you can lock in that profit if you close these orders right now.

However, some of your deals are potentially bringing you loses.

If you look at your balance, you will see it still equals $2000 as it will not change until you close all your opened orders.

But how can you track the total outcome of your opened positions?

To track the outcome of your trades altogether, you need to monitor your account equity.

It represents the account value that you will have had if all your orders were closed at that time.

Account equity includes your initial investment and floating profit or loss that your open positions have accrued.

Let’s see what you’ve got.

It looks like you’ve picked a strategy that works well for you, and your profit from winning orders is bigger than expenses from your lost deals.

Always track your equity and margin level.  

Margin level shows whether your equity is enough to support your open orders.

If your equity becomes less than a margin required for all your opened orders, you will get a margin call.

Whenever you open a new order, make sure your margin Level is 500% or higher. It is a good practice to keep your margin Level at around 1000%.

In this case, you will be able to maintain the order open even if the market temporarily goes against your prediction: you will be able to wait for the market trend to alter and avoid closing a losing trade.

You approach the danger zone if you margin level goes below 100%.

The margin call is triggered when your margin level hits 25%, just before your account balance drops below the point where it is unable to cover your potential loss.

Once it happens you need either to top up your account balance or to increase the equity...

...or close the position and fix the loss.

If you do not increase your balance after the margin call, stop out will be triggered at 15% margin level and your orders will be closed automatically.

This way your broker protects you from the potential losses that you cannot cover with your own investments.

OctaFX uses balance protection so that you cannot lose more than your initial deposit, even when trading a highly volatile market.

Here is a real example of margin call and stop out in action.

-17.60 USD will not be charged from the trader due to negative balance protection.

Using the trading calculator on OctaFX, you can learn what margin is recommended for the currency pairs and leverage ratio of your choice. It also shows the pip value for each currency pair.

For example, if you are trading 1 full-size lot in EUR/USD using 1:50 leverage, your required margin is $2319.18. In the case of EUR/USD, the calculator shows the value of a 1 pip on a full-size lot of EUR/USD, which is $10.

1. Leverage allows you to trade several times larger volumes than you could with your initial deposit.

It can multiply your profits but it also multiplies your risks.

Leverage is expressed in ratios.

2. A margin is a deposit required to maintain your orders open with a leverage.

Margin covers potential losses of your trade to a broker.

3. A margin call is a notice from your broker triggered when your losses are about to become bigger than your margin.

When you get a margin call you should either close your trade with a loss or add extra funds to your account to enlarge your margin.

4. Stop out is an automatic close of your trade when your losses become equal to your margin.

It protects your account from going negative.

In the next lesson, you will learn:

• What types of charts you can trade on
• How to analyze Japanese candles
• What time frame to choose.