If you are a complete beginner on the topic of leveraged trading and want to learn what a leveraged position is you have landed on the right page. After reading this article, you will have learned all the basic concepts of what a margin-traded position means and how it works.
Before continuing with this guide I recommend that you read up on some of our other guides to further educate yourself on the topic. Here are some beginner guides that will help you understand how it works.
Below is a summary of the explanation of a position in forex, stocks, and crypto, and if you keep reading this guide you will get the full explanation with some examples of real-world situations on how leveraged positions work.
Leveraged position at a glance
- Leveraged positions use borrowed money to increase the buying power in order to multiply profits (and losses).
- To open a the position, a margin requirement is needed which acts as collateral or initial deposit for the loan.
- A trader can choose the ratio used for each position in order to select the multiplier, for example, 1:25.
- When leverage is used to open a position, the position becomes vulnerable to a margin call which is a warning signal from your broker telling you that your position is at risk.
What does it mean to leverage a position?
A leverage position is a trade that has borrowed capital attached to it to amplify buying power.
When a trader adds credit to a position it means that he is borrowing money from the broker to increase the position size or buying power.
This happens automatically by depositing money, selecting the ratio, and opening a trade.
Suppose a trader chooses a ratio of 1:30.
This would mean that he increases the purchasing power of his position by 30 times.
For example, if the trader deposits $400, he would be able to open a position worth $12.000 at this ratio.
Every trader should carefully consider how to choose leverage ratio for a beginner before investing real money.
This is how it works
A position works by having two components:
- Leverage = The money borrowed from the broker
- Margin requirement = Your own deposited money
Each time you open a position with a multiplier you are required to add your margin capital as collateral for the loan.
The leverage is provided by your broker and is applied at the time of entry.
Before you open the position you are asked to choose your ratio.
Once the position is opened your profit and loss will be amplified to the degree of the margin chosen.
When the position is closed, the borrowed funds are returned to the broker, and your margin capital is returned to your account balance.
Any profits and losses are added or deducted from your margin balance.
To learn more about how losses work read our guides:
The ratios explained in an easy way
As explained above, a position is built up of your capital and the borrowed money you receive from your brokerage platform.
The ratio is the part of the position that is made up of borrowed money.
When choosing the amount of leverage for each position you are selecting a ratio of how much borrowed money you want to use.
The higher the ratio, the more money you borrow.
Ratios are usually expressed as numbers, for example, 1:25 or 25x.
The ratio is the multiplier of your margin requirement for each position.
Suppose you want to use $250 of your capital to enter a trade and you want to use a ratio of 1:55.
The ratio of 1:55 means that you multiply your own $250 by 55 to get the total position value.
In this case, the total value of the trade would be 55 x 250 = $13,750.
Why margin requirement matters
Before opening a leveraged position you are asked to put up collateral money.
This money works the same way as the collateral for a bank loan or a mortgage.
The margin requirement for a position is the amount of your capital that goes into the trade.
The margin requirement is closely related to the ratio and can be calculated once you know your total position value and the ratio.
Let’s say that you have deposited $800 in your margin account and you want to use $200 to open a position.
These $200 will be your margin requirement to access the added funds.
Once the margin collateral is chosen you can select the margin ratio to get the position value that you wish.
For example, you could choose a ratio of 1:15 combined with your $200 of margin capital which would result in a total position value of $3000.
The calculation for this trade would be 15 x $200 = $3000.
What happens if you get margin called?
As you already know, the margin is an important part of each position.
Every time you open a position, you select your margin.
Now, if your position goes against you and you suffer a loss in your position your broker will give you a warning when you are running out of margin capital to support the losses.
Let’s say that you opened a position with $250 of margin capital with a credit ratio of 1:30.
The total position value would be $7500.
All the losses you take will be calculated on that total position value, $7500.
This increases the total loss per tick when the market moves against you and the losses will be magnified.
Should the total loss value get close to your initial margin collateral of $250 you will receive a margin call from your broker telling you that you are running out of funds to support the overall losses.
In this case, you can either close the position to take the loss or add more margin capital to support the losses.
A margin call calculator can help you prevent getting margin called in the first place.
Should you do nothing and leave the position to chance you might get liquidated.
Liquidation means that your position reaches the liquidation price and you lose all your funds as the position is closed out.
Related: Liquidation price calculator
Examples of how to increase profits
No doubt trades with leverage increase profitability.
Leverage actively multiplies all the profits your earn on each trade.
Here is an example of how it affects profits compared to a position without margin.
Example 1
Suppose you open a position worth $800, without a multiplier, and you make a 2% profit.
This would result in a total profit of $16.
Example 2
Let’s assume that you make the same trade of $800 but this time you use a multiplier of 1:35.
This 2% profit would now result in a total profit of $560.
The simple calculation for this is to take the total position value and add the profit in percentage.
Calculation:
800 x 35 = $28,000 (position value)
28,000 x 0.002 (total profit) = $560
This is how a leveraged position makes more money than a position without borrowed capital.
Keep in mind though that this also affects losses in the same way.
It gives the option to go long and short
Another interesting benefit of using a multiplier for your position is that it gives you the option to short-sell the market.
Short-selling with leverage is a way of betting on a declining market and making a profit when the prices fall.
The way a short position works is that you borrow contracts from your forex broker and sell them to another trader.
Once you sell them to another trader and the prices fall, you will make a profit.
To close out the short position you buy back the contracts and the profits are added to your margin balance.
Short-selling is only an option if you trade margin.
We recommend that you use our short sell calculator to find out your profit, loss, and total position size while short-selling.
What markets offer leveraged positions?
To open a position you need to sign up with a trading platform or a broker.
These brokers are usually CFD brokers, forex brokers, and the best leverage trading platforms for crypto and offer traders margin-based accounts.
Through one of these brokers, you can access leverage in any market of choice, such as:
- Cryptocurrency
- Forex
- Stocks
- Commodity
- Index
- Metals
Since leverage is used in long-term investing as well some markets offer leveraged ETFs with lower leverage ratios.
These are the added costs you should expect
These positions have increased commissions and fees due to the increased position size.
Since the total spread commission or trade fee is calculated on the total position value, leveraged positions have a higher fee than standard positions.
To know how much you will be paying in fees for each position you should calculate the standard fee and then add your ratio or simply calculate your total position size first and then add the commission.
It is important to consider how this could impact the cost of your trading.
Most novice traders don’t realize how much money they spend on trading fees until it is too late.
Leveraged positions also incur an interest payment for traders who hold their positions overnight.
This fee is deducted from your margin balance at midnight every time you hold your position for longer than a day.
Typically, the overnight fee, or management fee, costs around 0.035% and is calculated on your full position value.
This cost is the same as your monthly interest payment on your loan or mortgage.
