A beginner’s guide to leverage and margin in trading

As a trading beginner, there is a plethora of different processes and terminologies you have to wrap your head around when you begin your trading journey. No matter what style of trading you choose, it’s undoubtedly a complicated process involving many different aspects, which will take time and dedication to fully comprehend.
In addition, the level of success you achieve will be heavily influenced by how effectively you learn and apply these different components of trading.

Leverage and margin in trading is one aspect which as beginner you must certainly learn, and can have a large impact on how profitable your trades are. In light of this, read on, to learn what is leverage and margin in trading, and more importantly, how you can incorporate them effectively into your trading journey.

What is leverage and margin?

Leverage and margin are two key components of a trading style known as leverage trading, and play important roles in how these trades are carried out. Leverage trading is where traders can open a position on an asset, and gain greater exposure to the market, from an initial deposit which is much lower in comparison. To best understand this process, let’s apply it to the use of contracts for difference (CFD), wherein a position is opened speculating on the market movement, instead of traditional trading where you would own the underlying asset.

When trading CFDS, the asset in question will have a leverage ratio which dictates how much exposure you can gain in accordance with a particular value of a deposit. This initial deposit is known as the trade margin.
Depending on the value of the leverage ratio, your initial margin will allow you to open a position which is worth much more than the margin you put down. Using this method, you can trade with much higher exposure, meaning your profits can be significantly greater than if you were to trade without leverage.

However, whilst your profits will be greater with leverage, so will your losses should your trade fail.
Any losses will be calculated against your position’s total exposure value, and not the value of the margin you initially put down. How can you use leverage and margin in trading? With a more detailed understanding of leverage and margin, here’s how it can be applied to your trades:

Step 1
The first step in using leverage and margin is to find an asset to trade. In this case, we’ll assume that you’re trading CFDs on the stock market, and are looking to open a long (buy) position on an asset.

Step 2
Once you have identified the asset you wish to trade, you must then find out the leverage ratio. In this case, we’ll say the leverage ratio on your particular asset is 1:20. This means that if you wanted to open a position worth £20,000, you’ll have to put down a margin of £1,000. Alternatively, if you wanted to open a position worth £60,000, it will require a margin of £3,000. The larger the ratio, the more exposure you’ll gain, so be aware of what assets, margin values and leverage ratio you are comfortable to trade with.

Step 3
Once you have decided on your margin and the exposure you’ll gain, you can execute the trade. Upon closing the trade, you will either have gained a profit or incurred a loss, and the return of your trade will be calculated against your total exposure, not the initial margin. This further illustrates how leverage and margin can be both highly beneficial to your trading, but also fairly damaging if used incorrectly.

Now that you have a complete understanding of how leverage and margin work in trading, you can use this guide to establish a greater chance of profit, whilst also manoeuvring the process more cautiously.