Chapter 34, Part I. A Bit More About Leverage. Page 4

Pipruit: Well margin is precisely an amount of money that is demanded by your broker that we’ve spoken of just above. So, if broker provides 1:100 leverage and we want to control 100 K, we have to provide 100,000/100 = 1000 USD. This is the margin. If we will provide less, then we will be able to control a smaller total value – other words, our maximum position value will be smaller. Brokers usually appoint minimum deposit value that could be used for trading and maximum leverage that could be provided. For example 500 USD and 1:500. This combination gives us minimum required margin 500 USD, while our total trading assets could be as large as 250 K.
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Commander in Pips: And why do brokers’ need it? What is margin?

Pipruit: Well, broker uses it in two ways. First, this is some kind of guarantee of fulfillment of our obligations with those participants who will be a counterparty to our trades. This is some kind of first call. Second, if there will be slippage on the market this deposit will act as a cushion for the broker and it will allow him to close position without a personal loss. In general a broker has an average position of his clients within each trading pair. The broker unites it into single pool and acts on the interbank market now with this larger position, while it continues separate accounting within the clients inside itself.
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Commander in Pips: Can you somehow estimate leverage, based on margin provided?

Pipruit: Yes, usually margin shows as percent range. You have to divide 100 on percent margin to get a leverage. For example, if margin is 5% then 100/5 = 20:1 leverage.
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Commander in Pips: Correct! What types of margin do you know?

Pipruit: Well in general, there are two types of margins – “Initial margin” and “Maintenance margin”. The first margin is demanded by the broker to initiate a position, while the second is the absolute minimum of margin – if it will be reached you should deposit additional funds and reestablish margin at an acceptable level. For example, if initial margin is 1000 USD and maintenance is 500 USD, then initially you can open lot with 1000 USD. If price will move against you, your maximum floating loss could be no more than 500 USD. As long as loss does not exceed 500 USD, you can hold your position.
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Commander in Pips: And what will happen if it will exceed 500 USD?

Pipruit: Well, this calls as “margin call” – lack of sufficient collateral for getting leverage, you have to add 500 USD or your position will be forcefully closed by the broker. Broker will return you the rest of your money.
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Commander in Pips: And why broker needs this maintenance margin?

Pipruit: That is what you’ve called a cushion. The point is when margin falls to crucial level – the broker’s risk to get unwelcome loses at its own expense becomes significantly higher. If your money will not be enough to fulfill your obligations with the counterparty – then the broker will have to do it anyway out of its own expenses. That’s why maintenance margin is some kind of insurance for a broker that it will not catch loss during solid slippage, for example.
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