Leverage Trading vs Margin Trading: 2 Main Differences

What is the difference between leverage and margin?

The difference between margin and leverage is that margin is your collateral money and leverage is the borrowed funds that you receive from your broker.

You need margin to be able to access credit much the same way that you need a collateral downpayment on a mortgage to be able to receive your loan.

They then go hand-in-hand when you later open a leveraged position.

Your margin capital acts as risk capital and when you lose money it is withdrawn from your margin account balance.

Once the position is closed out your margin balance is returned to your account and the credit line is returned to the broker.

All profits and losses are calculated on the total position value where both values are combined.

Once you see the difference, you can understand how margin and leverage work together when markets move fast.

For example, controlling a $1,000 position with a $100 account would require 10x exposure, not something beginners should ever attempt, but useful for explaining the math.

However, if you have a $200 account size you only need to use 5 times more purchasing power.

The more margin capital you put up the less credit is required to reach your position size.

Margin ratios are also explained in terms of how many percent of a position is margin capital.

In our previous example of the $100 account size, you need a 10% margin to trade with $1000.

A 1% margin requirement equals 100× exposure, which means even tiny price moves can wipe out your entire margin.

Margin explained

Margin is the collateral capital that you invest to trade with leverage and is the full amount of your account.

Trading with borrowed funds means that you borrow money and to access this “loan” of cash you need to put down an initial downpayment.

This downpayment is the margin that is also seen as your risk capital and it is always your margin that is lost when your trade goes against you.

Margin goes up when you close winning trades and down when you take losses, it’s simply your risk capital.

It’s similar to putting down collateral for a loan, except markets move faster and your collateral can disappear quickly if the price turns against you. Every loan has an initial collateral payment that you are required to pay to receive a loan.

The collateral ratio varies depending on how big your loan is and there is also an interest to be paid back to the lender.

Most brokers who offer leverage trading in different financial assets will add leverage fees. These fees come out of your margin balance and can add up quickly if you hold positions for long. Usually, the fee is calculated for all positions kept overnight and paid at midnight.

Leverage Explained

Compared to margin, leverage in trading is the borrowed funds you receive after you deposit your margin capital and is the added buying power to your positions.

You can set your leverage level, but smart traders first check where their liquidation price will be before opening a position.

For example, if you choose a leverage ratio of 1:5 you will get access to five times your initial deposit.

Let’s say that your initial margin deposit was $500 and if you choose to open a position with a 1:5 ratio, your maximum position size would be 5 x $500 = $2500.

In this case, your trading margin requirement to use this ratio was only 20% which means that you only had to put down 20% of your capital to receive the credit to open your position.

Leverage widens your gains and losses, but in reality the losses often hit much faster when the market turns.

Only traders with solid risk management and good timing can handle leverage without blowing up.

Initial margin capital vs leverage

Depending on how much capital you decide to deposit in your investment account you can calculate how much margin you need to use to reach a certain position size.

Let’s say that you want to trade $10.000 lots and you deposit $5000 as your initial margin capital you only need to use a 1:2 leverage.

Your initial margin capital is what your account is built of and it is what sets the scene for your trading activities.

If you deposit more margin, you don’t need as much leverage, and that usually means lower overall risk.

To calculate your full position size you always use your initial margin capital multiplied by the margin ratio.

For example, if your initial deposit is $1000 and you are going to trade with a ratio of 1:20 your maximum position size is $20.000. See the calculation below:

$1000 x 20 = $20.000.

Use our leverage trading calculator to learn how much initial margin capital is required for each position to keep risk contained to your preferred level.

Leverage ratios

The leverage ratio you choose has a direct impact on how much margin you need to add to your position.

For example, if you choose a high ratio such as 1:50 you only need to add 2% of your margin capital to the position.

This significantly increases the risk of your position but it reduces the overall margin invested. If you choose to use a lower ratio, your margin requirement increases.

Let’s say that you are going to use a 5 times credit, then you will need 20% of your margin capital to open a position.

Below is a table that further explains the concept of these ratios.

I have chosen to add the position size to the left and show you how much of your margin capital you need to put down for each leverage ratio.

Higher leverage means you need less margin to open the position, but the chance of liquidation goes way up.

For example, to open a position of $5000 with a 1:2 ratio you need $2500 but if you use a ratio of 1:60 you only need $93.75.

Anything above 100× exposure is extremely risky. Even tiny price moves can liquidate the whole position.

Questions asked by other traders