Leverage allows increased market exposure using a relatively small deposit. This means that any move on the market can mean a much higher return on investment than with traditional forms of investment without the use of leverage.
However, it’s important to keep in mind that when, or if, the market moves in the opposite direction than you expected, the sum of your loss is also magnified.
Below are some examples that show how leverage works.
Example I:
The first trader wants to take a position on EUR/USD with a volume of 0.1 lot. The contract value is EUR 10,000 and the leverage is 30:1, or 3.33% of the deposit.
This means that the trader needs only 3.33% of the EUR 10,000 to open a position.
Example II:
The second trader wants to open a long position on a CFD S & P500 with a multiplier of 50.
Now let’s assume that the value of the CFD contract for S & P500 is USD 2,000.
To open a position without leverage, the trader would need 2,000 x 50 = USD 100,000 on their account.
If the leverage is 20:1, the trader needs 5% of the contract value to open the position. Therefore, having a USD 5,000 deposit can conclude transactions with an exposure of USD 100,000 (2,000 x 50).
Advantages of Leverage
- When compared to the initial investment, profits can be much higher.
- Traders can open much larger positions than with physical purchases.
- Leverage allows traders to use only a part of their capital for investment, which also makes it easier to invest in different instruments at the same time.
Disadvantages of Leverage
- Just as potential profits can be increased, so can be potential losses.
- Being able to open much larger positions than with traditional investments can make it easier to lose sense of potential losses.
- Diversifying your capital can make it harder to keep track of the total value of your investments.
Margin Level and Margin Required
The margin level determines the deposit that is required to keep open positions. To open and hold positions, a trader must have sufficient funds to secure it. Free margin determines the capital that remains on the account to open subsequent positions, and to cover the changes in the balance resulting from price movements from already opened positions.
With XTB the margin level at which the most lossy position is closed is 50%. This is calculated by dividing the equity with the required level of collateral, and multiplying it by 100%.
On xStation 5, XTB’s trading platform, you can find the margin level in the bar at the bottom of the screen on the right. The mechanism that closes the positions is a security mechanism that limits the risk of a negative balance in the event of sudden movements in the market.
It’s worth remembering to always keep the margin level above 50%, for example by depositing additional funds or by closing several positions.
