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The Difference between Leverage and Margin in Forex

Leverage and Margin in Forex are the terms all beginners should know before selecting a specific trading strategy. Sometimes, investors may need more capital than they currently have to invest in a potentially profitable trade. So, the only chance to get the required funds is to borrow them from a broker. Some beginners may consider forex leverage and margin as something equal.

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Well, the two terms are different and it is very important for novice investors to clearly understand the difference between leverage and margin, as both can increase either big profit or losses.

What Is Leverage and Margin in Trading?

When you see a potentially profitable trade, you might want to invest more than you have. Sometimes, the only way to generate additional capital is to borrow it from a broker. Otherwise, you simply cannot invest more than you can afford, which means lost profit opportunities. Leverage and margin are the two terms you need to be well aware of before taking this step.

Margin Meaning Explained

The term describes the difference between the sum you borrow to execute a trade and the total security value kept in the margin. To perform margin trading, one needs to open a margin account with a chosen broker.

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The initial investment that he or she makes, will be used as the minimum or initial margin. It also represents the initial capital you want to invest in an underlying trade.

You are not obliged to invest all your funds right at once. Traders can keep a part of their capital that will later act as the maintenance margin.

A practice known as the margin call describes the sum that falls below the value. When a trader receives the margin call, he or she is obliged to make another deposit to cover the negative difference. Sometimes brokers ask to pay back the full sum with the use of leftover cash.

Leverage Meaning Explained

Leverage is an approach of borrowing needed money to invest in a trade and amplify potential returns, that will give a chance to pay off the debt and keep the profit. As a rule, leverage in trading refers to the ratio between the allowed amount to invest in trade and the money that has been invested.

For example, a trader spends RS 100 for every 10,000 in increments. So, we actually have the leverage of 1:100.

On the one hand, the chances of generating profits are quite high. At the same time, it is possible to lose a significant sum of borrowed capital in case of failure.

The Key Difference between Leverage and Margin

Here are several crucial factors that explain the key difference between leverage and margin in trading:

  1. Leverage reflects the purchasing power after borrowing money from a broker.
  2. When using margin trading, borrowed funds also act as collateral, which makes it possible for investors to carry out huge trades costing more than they can afford.
  3. Some experts consider leverage as a lower-risk approach, as such practices are more cautious within a longer timeframe.
  4. Oppositely, short-term margin trading offers higher decent returns, especially when acting on markets featuring high liquidity.

Additionally, traders can use other strategies to generate margin. Those strategies are not necessarily related to margin accounts.

The Bottom Line

Margins accounts can be used to generate leverage. However, only a few trades with enough experience use such techniques when trading Forex or securities. Beginner investors must be very accurate and cautious when using the tactics of leverage trading. The main issue is that a few newbies are aware of how it works not to mention the understanding of the market functioning. So, the best solution is to learn how both approaches are applied to clarify the difference between leverage and margin in trading.

This material does not contain and should not be construed as containing investment advice, investment recommendations, an offer of or solicitation for any transactions in financial instruments. Before making any investment decisions, you should seek advice from independent financial advisors to ensure you understand the risks.