Part I. A Bit More About Leverage

Pipruit: Right, but I tell you what – I will better trust professionals.
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Pipruit: So, sir, applying our conclusions to Forex, we come to result that we can trade 1 standard lot, only if we have account of $10,000?
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Pipruit: I see, and what to do, if I have just 2000-5000 USD?​

Pipruit: Right. So, we should not open an account with 25$ or standard account with just 5000 USD just because brokers allow traders to do that.
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Pipruit: Me? All right. In the Ancient World Archimedes said that he could lift the Earth by leverage if you can give him a long enough lever and a fulcrum to place it on. So, it tells us that with just a small physical effort, leverage lets you move much greater objects. This is physical leverage. Since we are discussing money leverage, we have to replace word “physical effort” with “money”. Then it turns that we can control large amount of money with small one. For example 1:100 leverage allows us control 100 K USD with just 1000 USD. That’s why it is called 1:100. Or, with 5000 USD we can control the same 100K USD, if we have leverage 1:20.
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Pipruit: Well this is a broker’s service. It demands you to provide 1K, while allows you to borrow the other 99K. So, let’s say we have 1:100 leverage and control 100,000 USD with just 1000 USD. If our assets will increase to 101 K and we earn 1000 USD more we will get 100% outstanding return on our capital, since money that we’ve provided for trading is just the same 1000 USD. Hence 1000 of profit/1000 of initial assets x 100% = 100% gain. If we have 1:1 leverage, or trade with our money only, and everything else is the same we will have just 1K/100 K x100% = 1%. But what is the other side of leverage? IF you assume reducing of your position instead of increasing with the same 1000 USD you will get -100% or total loss of all assets with 1:100 leverage, or just -1% loss if you use no leverage. That is the second edge of the leverage sword. The pity is that many traders don’t fathom the idea that this sword cuts equally well from one side to the other.
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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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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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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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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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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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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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Commander in Pips: Right you are. I just want to add some another terms with margins. Some software shows such terms as:

- Margin required – that is the same as initial margin;

- Total margin or account margin – total margin that you have at your disposal;

- Used margin – sum that was reserved as collateral for current open positions;

- Usable margin – this is difference between Total margin and used margin.

Not all of them are used simultaneously, but sometimes we can see some of these terms. For example, Metatrade 4 – well known software also shows “Margin level”. This stat changes over time and shows the ratio Account Equity/Used margin. Commander in Pips: Ok, let’s pass through it.

First of all, let’s say that you’ve just opened account with some broker in EUR. Your initial deposit 5000 EUR and broker allows you to use as much as 100:1 margin. Then, right at the moment when your assets just were deposited on account you will see the following statement by software:

Action	Account Balance	Total Equity	Flow Profit/Loss	Used Margin 100:1	Usable Margin
-	5000 €	5000 €	- €	- €	5000 €

You’re just starting itching to start. Finally, you’ve found nice context to open with 1 lot of some pair. Then statement has changed:

Action	Account Balance	Total Equity	Flow Profit/Loss	Used Margin 100:1	Usable Margin
-	5000 €	5000 €	- €	- €	5000 €
+1 Lot
-	5000 €	5000 €	- €	1000 €	4000 €

You can see, that broker has applied the level of margin that it has promised to you, and set aside as collateral 1000 EUR. So your usable margin has reduced to just 4000 EUR. At the same time, not too much time has passed, so you do not have any Flow Profit/Loss (also known as Floating Profit/Loss) on your position. Later you start to see, that the market is moving against you and statement has changed due to this reason:

Account Balance	Total Equity	Flow Profit/Loss	Used Margin 100:1	Usable Margin
5000 €	4650 €	350 €	1000 €	3650 €

How this could happen?