Leverage and margin
Margin is what a position requires as collateral. Leverage is what it does to the size of your mistakes.
10 min read · beginner · lesson 5 of 6
What this covers
- Distinguish margin from leverage
- Calculate the effective leverage a position actually carries
- Calculate the account move produced by a small price move at a given size
- Explain the sequence that ends in liquidation
- Explain why recovery is harder than the loss that caused it
Two separate things
- Margin
- The collateral a broker holds against an open position. A requirement, expressed as a percentage of position value.
- Leverage
- The ratio of position size to the capital behind it. A consequence of how large a position you opened, not a setting you switch on.
- Notional
- The full value of what the position controls, as opposed to the margin posted against it. The number that determines the profit and loss.
- Effective leverage
- Total notional across all open positions divided by account equity. The only leverage figure that describes actual risk.
What leverage actually changes
Leverage does not change the market. Price moves the same distance whether the position behind it is small or large. What changes is the size of the account move that distance produces.
The available leverage on an account sets a ceiling on position size. It does not set the position size. A trader with access to high leverage who takes modest positions carries modest risk. The number quoted by the broker describes what is permitted, not what is sensible.
The figure worth tracking is effective leverage: everything currently open, valued at full notional, divided by the equity behind it. An account using a fraction of available margin can still carry high effective leverage if the positions are large relative to equity, and it is that ratio rather than the broker's ceiling that decides how a bad day feels.
The same move at two sizes
IllustrativeAll figures are illustrative.
Account: 10,000. Instrument moves 50 pips against the position.
At 0.1 lots, roughly 1 dollar per pip, the loss is 50, or 0.5 percent of the account. Recovering it requires a 0.5 percent gain.
At 2 lots, roughly 20 dollars per pip, the same 50-pip move costs 1,000, or 10 percent. Recovering it requires an 11.1 percent gain, because the base is now smaller.
The market did the same thing in both cases. The difference sits entirely in the size decision made before entry.
What a drawdown requires to recover
| Account loss | Gain needed to return to flat |
|---|---|
| 5 percent | 5.3 percent |
| 10 percent | 11.1 percent |
| 25 percent | 33.3 percent |
| 50 percent | 100 percent |
| 75 percent | 300 percent |
The sequence that ends in liquidation
It runs in a fixed order and each step removes an option.
Equity falls as the position moves against you. Free margin, the buffer between equity and what the open positions require, shrinks. At a defined level the broker issues a margin call: add funds or reduce exposure. Below a second level, the broker closes positions itself.
The trader does not choose which positions close or at what price. This happens at the worst point of an adverse move, which is frequently near the point where it reverses. Liquidation converts a temporary loss into a permanent one and removes any decision from the trader.
The defence is entirely upstream. By the time a margin call arrives, every remaining choice is a poor one.
Key takeaways
- Margin is collateral. Leverage is the ratio position size creates.
- Available leverage is a ceiling on size, not an instruction.
- Effective leverage across all open positions is the number that describes real risk.
- Losses compound against a shrinking base. A 50 percent loss needs a 100 percent gain.
- Liquidation removes the decision from the trader at the worst possible moment.
Common mistakes
- Reading a high leverage ratio as an invitation to use it.
- Sizing positions against available margin rather than against acceptable loss.
- Tracking margin used while ignoring total notional against equity.
- Adding to a losing position while margin is already stretched.
Knowledge check
OptionalRelated
- Position sizing and risk per tradeMarket Foundations
- Long and short positionsMarket Foundations