What is Margin and Leverage?

One of the benefits of trading Forex and Contracts For Differences (CFDs) is that you can use leverage to enhance your trading gains. Financial leverage allows you to borrow capital to increase your position size. Rakuten Securities Australia will use the securities you purchase or sell-short as collateral. Leverage increases your risk of loss, at the same time as enhancing your ability to generate profits, acting as a double edge sword. To be able to use leverage, you will need to open a margin account.

What is Leverage?

The use of financial leverage is common in several industries. For example, if you plan to purchase a house, you are likely to apply for a mortgage. A mortgage allows you to use borrowed capital to purchase a house. The mortgage lender will require that you post a percentage of the capital needed to purchase the home (usually 20%) as well as pledge the house as collateral. Leverage that is issued by your Forex broker is similar to the leverage that you can attain from purchasing a home. Your Forex or CFD broker will enhance the capital you can use to trade, and use the securities that you purchase and the equity in your account as collateral. You cannot withdraw any of the borrowed-capital that is used to leverage your securities.  

  Your broker will likely have a cap on the size of any individual position, which will also be a function of the size of your account. For every position you add, you will need to be able to cover at least the maximum Rakuten Securities Australia believes you can lose during the next 24-hours. In some instances, we might offer leverage as high as 400-1. Generally, we will limit the number of open positions you can take with highly leveraged trades.

What is a Margin Account?

To be able to use leverage, you will need to open a margin account. When you apply, your broker will ask you questions about your experience to determine how much leverage to offer you. A margin account will have several nuances that you should understand. Generally, when you use leverage, Rakuten Securities Australia will charge you a small interest fee for the capital you use for leverage. Additionally, we will monitor and report your use of leverage per open position. Rakuten Securities Australia offers two different margins accounts for professional accounts. This includes a standard account with leverage of 100-1 and a high margin account with leverage up to 400-1. Margin serves as a good faith deposit, which Rakuten Securities Australia uses as collateral for trades. There are two different types of margin. The initial margin is the amount of capital we require for you to initiate a trade. 

  Once the exchange rate changes, any additional funds that a broker requires is referred to as maintenance margin. If the exchange rate generates an unrealized loss, a broker will take capital from your account to cover the unrealized loss. Rakuten Securities Australia is constantly monitoring your open positions to determine the volatility of your open positions. We will likely state in any margin agreement that they have the right to change the margin requirements at any time. If the capital in your account reaches a specific threshold where you might be in danger of experiencing a loss that exceeds the money in your account, we might issue a margin call.

What is a Margin Call?

If you experience an unrealized loss that exceeds the margin account threshold, your broker will ask you to immediately increase your equity to cover the potential loss. Rakuten Securities Australia will have clear rules about the timing of adding capital. They will also have consequences for not meeting the margin call, which could include the immediate liquidation of open positions to cover your unrealized loss.

How Does Leverage Affect Trading

When you use leverage through your margin account, you will experience benefits and costs. Let’s look at an example of a 10,000 USD/JPY where you post 1% or $100 when you place the trade. For the right to use 9,900 US dollars, any Forex broker will charge an interest fee. This rate will be a market rate for using the capital each day. The benefits of using leverage can be substantial. Let’s say the exchange rate of USD/JPY moves 2% in your favor. The value of the $10,000 would change to $10,200. The returns on a non-leveraged position would be 2%, but on a leveraged position where you only posted $100, your return is 100%. Keep in mind that this is a double-edged sword. If you lose 2%, you will have lost your initial margin.

Risks of Trading with Leverage

In this instance, a Forex broker would ask you for a maintenance margin to cover any additional losses. What is clear is that leverage enhances both your gains and your potential losses, and magnifies the changes in an exchange rate generating larger gains or losses from small moves.

Why Is Leverage Offered in Forex and CFD Trading

Leverage is typically offered to provide enhanced returns on instruments that generally have low levels of volatility and ample liquidity. Forex leverage can reach levels up to 400:1. This is because currency pairs like the EUR/USD or the USD/JPY have historical volatility that averages at 10%. This compares to individual stock which has historical volatility as high at 100%. Forex markets are generally very liquid, less volatile, and open around the clock, making them great candidates for leverage.

Conclusion Leverage allows you to use borrowed capital to enhance your returns. Rakuten Securities Australia will provide leverage of up to 400-1 on Forex trades, based on your capital and experience. To use leverage you will need to open a margin account. There are several costs and benefits to using leverage, including enhanced gains which can be offset by large losses. Before you open a margin account you should be aware of issues that can arise if your capital falls below the required limit expected by Rakuten Securities Australia.