Tag: Leverage Trading

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Forex Course

190 – Introduction To Carry Trading The Forex Market

Introduction 

Introduction 

Introduction 

When it comes to forex trading, we have so far covered how you can make money by taking advantage of price fluctuations. What, then, do you do when the price of a currency pair remains relatively stable for extended periods? Certainly not nothing! You carry trade.

In the financial market, carry trade means borrowing a financial asset with a low-interest rate, sell it, and purchase another one that pays a higher interest rate. That means the cost of borrowing (lower interest rate) is lower than the proceeds (higher interest rate). In this case, the profits you earn is the difference between the two interest rates, also known as interest rate differential.

For us to explain how the carry trade works, we first need to explain how the interest rate in the financial market works.

Carry Trade Example

Say you go to a bank and take a loan at an interest rate of 2% per annum. If the loan amount is, say, $2000, the interest charged per year would be:

= 2/100 * 20000 = $400

Now, instead of putting the money under a mattress, you decide to buy a corporate bond, which in total, pays a yearly interest rate of 10%. This means that at the end of one year, you should expect interest income of:

= 10/100 * 20000 = $2000

In this scenario, you have earned $2000. Remember, the borrowing cost was $400, which means you have a profit of $1600. In other words, you have earned an 8% in terms of interest rate differential.

If that doesn’t sound like much money, let’s see how you feel when we apply leverage to the borrowing.

Leveraged Carry Trade Example

Say you have a stock portfolio worth $20,000 and put this up collateral for a $2,000,000 loan with an annual interest rate of 2%.

You take this money and invest in another financial asset that pays an annual interest rate of 10%. In this scenario, the interest rate differential is still 8%. How about your profit?

= 8/100 * 2,000,000 = $160,000

With collateral of $20,000, you have made a profit of $160,000. That is an equivalent of 800% return.

Currency Carry Trade

In the forex market, if you let your position stay overnight, you will be charged a rollover fee. The rollover fee is the interest rate differential between the two currencies in the currency pair. Your account will be debited or credited accordingly, depending on whether the interest rate differential is positive or negative.

Stay tuned to learn more about Carry Trading in our upcoming articles.

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Forex Basics

What Are the Advantages of 1:1 Leverage in Forex Trading?

When it comes to leverage, you often see larger numbers being advertised, brokers trying to entice in new traders and new webers with the promise of sky-high leverage. In fact, the new standard of leverage being given by brokers these days is around the 500:1 level which would have been unheard of a few years ago. Some people, however, still swear by simply not using leverage, to use an account with a 1:1 leverage which basically means that you will be using your own money and only our own money, not borrowing from the broker at all. This does of course come with some advantages, advantages that we will be looking at in this article, so let’s jump in and see what the advantages of trading with a leverage of 1:1 are.

When it comes to leverage, you often see larger numbers being advertised, brokers trying to entice in new traders and new webers with the promise of sky-high leverage. In fact, the new standard of leverage being given by brokers these days is around the 500:1 level which would have been unheard of a few years ago. Some people, however, still swear by simply not using leverage, to use an account with a 1:1 leverage which basically means that you will be using your own money and only our own money, not borrowing from the broker at all. This does of course come with some advantages, advantages that we will be looking at in this article, so let’s jump in and see what the advantages of trading with a leverage of 1:1 are.

When it comes to leverage, you often see larger numbers being advertised, brokers trying to entice in new traders and new webers with the promise of sky-high leverage. In fact, the new standard of leverage being given by brokers these days is around the 500:1 level which would have been unheard of a few years ago. Some people, however, still swear by simply not using leverage, to use an account with a 1:1 leverage which basically means that you will be using your own money and only our own money, not borrowing from the broker at all. This does of course come with some advantages, advantages that we will be looking at in this article, so let’s jump in and see what the advantages of trading with a leverage of 1:1 are.

What Is Leverage? 

Before we do that though, a very brief overview of what leverage actually is. Leverage is basically a way of using more money to trade with than you have in your account. If you have a leverage of 100:1, it would basically mean that for every $1 in your account, your broker will let you trade with $100, they would simply lend you the other $99 in order for you to trade. So an account balance of $1,000 would have the trading power of a $100,000 account. This enables you to place larger trades giving you larger profit potential, but it will also increase the risk that you are putting on your balance with the larger trade sizes.

So there are certainly advantages to trading with a higher leverage, especially the profits that we are all after. There are however advantages to keeping your leverage low, so let’s take a look at what they are.

Advantages of Leverage

One of the main advantages to keeping your leverage low is the fact that it enables you to better manage the risk on your account and can allow you to survive for a longer period of time during a period of lots of losses. If we have a trading power of $100,000, this would mean that for an account with a leverage of 100:1 they will only need $1,000, however for an account with a leverage of 1:1, they would need the full $100,000, sounds like a disadvantage needing that much, which is true, but hear us out.

When we put on a trade with an account with the leverage, and the value of the trade drops $1,000, you technically still have $99,000 right? Wrong, due to the leverages, you were able to place those trades, but the $1,000 drop will have completely blown your account. With the leverage at 1:1 however, your account would be set at $99,000, with just the $1,000 lost. So it basically allows you to survive larger movements and consecutive losses that would have otherwise blown a leveraged account.

Transparency

There is also a lot more transparency when it comes to a leverage of 1:1, what you see in your account is what you have and what you have available to trade with. It can be quite confusing when trading with leverage, working out what your margin levels are, working out what your trading power is, and so forth. With the 1:1 leverage, you know exactly what there is and you know exactly what size trades you are able to make. This level of control and transparency can make it far easier to analyse your own account and to work out your risk management plans as well as your risk to reward ratio.

Balancing Losses

Trading with a low leverage keeps losses in line with your account balance, we mentioned before the heavy losses that can come from leveraged accounts, we just wanted to confirm this again. When we trade with low leverage, your losses will be in line with your account, you will be in a much better position to manage those losses and to be able to take a number of them at a time, not putting huge dents into your account. You also do not have any liability when not using leverage, many brokers will charge you a form of interest for using their leverage, so holding trades or simply placing them can mean that you have to incur a charge from your broker. Having a 1:1 leverage will mean that you are not borrowing any money and so do not have to pay the interest for doing so, another advantage and a day to save a little bit of your capital.

Impact on Margin Calls

Trading with a 1:1 leverage also helps you to avoid those pesky margin calls, these are levels set by your broker that are to do with your margin levels. When your margin level falls below the set amount then the broker will basically close all of your trades, this is done to protect you and to prevent you from going into negative balance, something that used to happen quite a lot in the past with leveraged trading. Not having to worry as much about margin calls can take a level of stress out of your trading. It will be very hard to get a margin call when trading on a 1:1 account simply because you are not borrowing any money to trade, what you see is what you have, and so the margin requirements are not as relevant.

Impact on Mental Health

Trading at a low leverage can also be beneficial to your mental health. Trading can be stressful, and when trading with leverage you are adding to that risk and the stress that you will be put under. You are risking more per trade and so each trade will give you additional stresses as you are risking your own money. With a 1:1 account, you are risking a limited amount and so the risks are lower, and so is the stress that you are putting yourself under. If you are a risk-averse person, then low leverage will be perfect for you.

So those are some of the advantages of trading with a 1:1 leverage, we are sure that there are some others out there there are of course some disadvantages too, as there is with any form of trading or leverage amount. You do need a lot of capital to begin with and it will take longer to make decent profits, but you need to weigh up the pros and cons, there are certainly a lot of advantages to trading low leverage, especially if you are not a fan of risk.

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Forex Course

33. Understanding Leverage & Its Relationship With Margin

Leverage

Leverage

Leverage

There is a close relationship between the Leverage and Margin. That is, both go hand in hand. In simple terms, the margin is used to create leverage. The meaning of leverage is similar to the margin. It is a facility provided by brokers, which allows a trader to take larger positions by investing a lesser amount than required.

Margin is expressed in percentage, while Leverage is expressed as a ratio

Leverage is the ratio between the capital a trader has in their account to the amount of capital he/she can trade. And this ratio is expressed in the form “X:1,” where X is the amount of leverage.

Expressing Margin in terms of Leverage

If a trader wishes to purchase one mini lot of a currency, they don’t need $1,000 in their account balance. Instead, they will need only a small percentage of the position size. And this percentage is referred to as Margin Requirement.

This same percentage in terms of a ratio is termed as Leverage.

For example, let’s say John wants to buy 100,000 units of USD/CAD. If the Margin Requirement is 1%, John will require only $1,000 to take this trade. That is, the Leverage for this trade would be 100:1.

Calculating the Leverage

Leverage is calculated using the below formula

Leverage = 1 / Margin Requirement

Considering the above the example,

Leverage = 1 / 0.01

Leverage = 100

Hence, the leverage will be 100:1.

Similarly, if the Margin Requirement is 2%, the Leverage will be 50:1.

Conversely, using Leverage, we can obtain the Margin Requirement as well.

Margin Requirement = 1 / Leverage

For example, if the Leverage is 500:1, the Margin Requirement  = 1 / 500 = 0.002

Hence, the Margin Requirement when Leverage is 500:1 will be 0.002 or 0.2%.

Mostly, Margin and Leverage have an inverse relationship.

Forex Margin and Stock Margin

Forex margin and Stock (Securities) margin are two completely different terms, though both are from the same trading industry.

In the Stock market, the margin is the amount a trader borrows from their broker to purchase a stock. Basically, it is like borrowing funds as a loan from their broker.

Whereas in the Forex market, the meaning of margin is different. Here, as we know, it is the amount of money a trader will have to keep aside with the broker as a deposit to open a margin position.

Hence, to sum it up, we can consider margin either as a loan provided by the brokers or as collateral collected by the respective brokerage firm.

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Forex Course

32. Understanding Stop Out Level In Margin Trading

Introduction

Introduction

Introduction

In the last lesson, we saw how Margin Level was found to be useful for giving meaning to Margin Call Level. Similar to the previous lesson, in this lesson, we shall be discussing another term that involves the dependency of the Margin Level. This lesson will be dealing with the understanding of what Stop Out Level is and also the implications and consequences of it.

Stop Out Level, and Margin Call Level have almost got the same meaning. There is only a thin line difference between these two. Hence, understanding the Margin Call Level is critical to comprehend Stop Out Level.

What is Stop Out Level?

Stop Out Level is a level that is set by the brokers, which triggers them to take action when the Margin Level falls below this specified level (Stop Out Level). That is, when the Margin Level breaks below the Stop Out Level, the broker forcibly closes some of the trader’s position, usually without their consent. The positions are liquidated because of the unavailability of the margin in the account.

Before the broker closes the positions, the trader is first intimated that their Margin Level has significantly reduced and is at risk. This intimation is called Margin Call. If the Margin Level falls much more than the Margin Call Level and goes below the Stop Out Level, the positions are liquidated. And this process of liquidation is called Stop Out.

The complete flow to Stop Out

If we were to dig deeper, the dependency of Stop Out level drops down to the basic concepts like Balance, Margin, Floating P/L, etc.

For instance, when a trader takes a position, the above terms come into action. If the trade is in profit, the floating P/L increases, and there are no worries about the margin call and stop out as the margin level would be considerably higher than the margin call level and the stop out level. But, if the trade is running in the negative, eyes must be on the margin call level as well as stop out level. Let’s get this point clearer, with an example.

Let’s say a trader has deposited $1000 into his account and has used $200 for taking few positions. Consider the Stop Out Level to be at 20%.

If the trades are running in a loss of$970. The equity for this is calculated as:

Equity = balance + floating P/L = $1,000 + (-$970) = $30

Similarly, the margin level will be,

Margin level = (Equity/used margin) x 100% = ($30 / $200) x 100% = 15%

Now, since the margin level has gone below the stop out level, the positions are scratched off. So, the trader will have booked a loss of $970. And the newly updated balance will be $30.

This brings us to the end of this lesson on Stop Out Level. Also, this completes all the terminologies that are involved in Margin Trading. Take the quiz below and stay tuned to learn a different lesson tomorrow. Cheers!

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Forex Course

29. Other Important Margin Trading Terminologies – Free Margin

Introduction
In the previous lesson, the concept of used margin and equity was discussed. Apart from having their importance, these terms prove to be significant to understand other terms as

Introduction
In the previous lesson, the concept of used margin and equity was discussed. Apart from having their importance, these terms prove to be significant to understand other terms as

Introduction

In the previous lesson, the concept of used margin and equity was discussed. Apart from having their importance, these terms prove to be significant to understand other terms as well. And in this lesson, we will be dealing with a term that has a close relation with used margin and equity.

Just to brush things up, the used margin is basically the total amount of money that is used up by the broker for all the positions. In other words, it is simply the sum of the required margin for all the trades. And equity, on the other hand, is the sum of the account balance and the unrealized P/L. Now that these definitions are clear let’s understand what free margin is.

Free Margin

Free margin is the difference between the Equity and the Used margin. That is, Free margin is the amount that is available for the trader to take new positions. It is basically the complemented version of the Used Margin. Used margin is the margin that is locked by the broker for taking positions, while free margin is the margin that can be utilized to open new positions. Free margin is also referred to as available margin, usable margin, and usable maintenance margin.

Calculation of Free Margin

As already mentioned, the Free margin is calculated by finding the difference between Equity and Used margin.

Free Margin = Equity – Used Margin

In the previous lesson, it was discussed that equity changes continuously when any positions are open. Now, since Equity is one of the factors that determine the Free margin, the free margin also keeps constantly changing when positions are running.

So, when a trade is performing well, the floating P/L increases, which in turn increases the Equity as well as the Free margin. And conversely, the Free margin decreases when the floating P/L decreases.

Now that the formula is clear let’s understand it better with some examples.

Let’s say a trader has deposited $1,000 to their account and currently has no positions open yet. So, the account balance at this point would be $1,000. The Equity will be the same as the account balance as the floating P/L is $0. Since no trades are open, there is no margin used. From this, the free margin is calculated as:

Free Margin = Equity + Used Margin = $1,000 + $0 = $1,000

Thus, it can be concluded that Balance, Equity, and Free margin is the same when no positions are open.

Now, let’s say the trader went short 10,000 units on EUR/USD. Consider the required margin to be $150. Also, assume that the trade is running in a profit of $30.

Equity= Account balance + Floating P/L = $1,000 + $30 = $1,030

The used margin will be equal to $150 (required margin) as there is only one position open.

Free margin = Equity – Used margin = $1,030 – $150 = $880

We hope you understood what Free margin refers to in a margin account. In the coming lessons, we will be discussing the Margin level, Margin call level, and Stop out level. Check your learnings by taking up the below quiz.

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Forex Course

28. What Should You Know About Used Margin and Equity

Introduction
In the previous lesson, three terms related to margin was discussed. There is another term called used margin, which comes under the same roof of the margin requirement and

Introduction
In the previous lesson, three terms related to margin was discussed. There is another term called used margin, which comes under the same roof of the margin requirement and

Introduction

In the previous lesson, three terms related to margin was discussed. There is another term called used margin, which comes under the same roof of the margin requirement and required margin. And in the lesson, this term shall be discussed in detail. Apart from that, this lesson shall touch base on the concept of Equity in margin trading.

Before diving directly into the topic, let’s first brush up the previously discussed terms as they form the base for this lesson. To Start off with the Required Margin, it is basically the units of currency that is needed to open a position. Note that this is not the actual amount of the position size but the amount after applying the Margin Requirement to the required margin.

Used Margin

The Used margin is the term that is very similar to the required margin. In fact, the used margin is the required margin. However, there is a thin line difference between the two.

The Used margin is the amount that is blocked by the broker when positions are open on a trader’s account. This definition might seem the same as that of the required margin. The difference is that the required margin talks about one single trade, while the used margin considers the sum of the required margin of all the trades. This is the amount that is ‘used’ by the broker when the trade is open and cannot be utilized for taking new positions. However, once the positions are closed, this used margin is unblocked and returned to the account balance.

Example

Let’s say a trader has $1,000 in his account and wishes to open trades on EUR/USD and USD/CHF.

Let’s assume he is willing to go short 10,000 units on USD/CHF and long 1,000 units on EUR/USD. Let’s keep the margin requirement for USD/CHF and EUR/USD to 2%, respectively. Before going into the calculation of the used margin, the required margin is calculated as follows:

USD/CHF

Required margin = Notional Value x Margin Requirement = $10,000 x 0.02 = $200

EUR/USD

Required margin = Notional Value x Margin requirement = $1,000 x 0.02 = $20

Therefore, when positions on both trades are opened, the used margin turns out to be $220*.

*Used margin = $200 + $20 = $220

Equity

Equity is a variable term that represents the current value of the account balance. Equity constantly changes when traders have their positions running. This proves to be an important term because it determines how many more positions can be taken on this account.

Calculation of Equity

The calculation of Equity is simple. It is the algebraic sum of the account balance and the unrealized P/L. When there are no positions open, the Equity will be the same as the account balance as the unrealized P/L is 0. And when there are any running positions, the Equity will be determined by both account balance and unrealized P/L.

Equity = Account Balance + Floating P/L

From this, it can be inferred that, when trades are running in the positive, the Equity rises, and when they’re in the negative, the Equity drops.

Thus, this completes the lesson on Used Margin and Equity. In the next lesson, some advanced term on margin shall be introduced. Don’t forget to take the below quiz before you move on.

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Forex Course

27. Understanding Margin Amount, Margin Requirement, and Required Margin

Introduction
In the previous two lessons, the basic terms in a margin account were discussed. And this lesson shall talk about the concept of Margin in detail. Precisely, this chapter

Introduction
In the previous two lessons, the basic terms in a margin account were discussed. And this lesson shall talk about the concept of Margin in detail. Precisely, this chapter

Introduction

In the previous two lessons, the basic terms in a margin account were discussed. And this lesson shall talk about the concept of Margin in detail. Precisely, this chapter of the course will deal with Margin, Margin Requirement, and Required Margin, as these three terms are very crucial when it comes to handling a margin account.

Margin, Margin Requirement, and Required Margin are closely related to each other.    Margin, the used term in margin trading, is the amount one needs to possess to open a position. And Margin Requirement and Required Margin are terms which mean the same but differ in notation. Now, let’s dive right into the topic and understand each one of the terms in detail.

Margin Amount

It is the amount that is used up or blocked by the broker to open and maintain a position in the forex. An important point to be noted here is that capital blocked is usually not the same as the lot size traded. Hence, the Margin Amount can be related to deposit or collateral that is payable to be the broker. However, this amount differs based on the number of lots traded.

The margin amount is blocked from the account balance when a trade is opened and is freed to the account balance when the trade is closed.

Margin Requirement

Margin Requirement describes what percentage of the position size is required to open a position. For example, if the Margin Requirement for a trade is 3%, then 3% of the position size is to be produced by the trader to open the position. So, when brokers mention that Margin in terms of percentage, then they are referring to Margin Requirement.

Required Margin

Required Margin is simply the Margin Requirement expressed in terms of units of currency. For example, if the margin requirement is 1% to take a position worth $10,000, then the Required Margin for the same will be $100.

Calculation of Required Margin

Since Required Margin is closely related to the Margin Requirement, the Required Margin is the product of Margin Requirement and the Notional Value.

Required Margin = Margin Requirement x Notional Value

Summary

Let’s sum up all the terms by taking an example. Let’s say a trader has $1,000 in his trading account. This amount can be read as a balance, as well. Let’s say he wishes to go long 10,000 units on EURUSD. Also, let’s assume that 2% of the position size value is required to open a trade.

The Notional value, Margin Requirement, Required Margin can be calculated as follows:

Assuming an account dominated in the USD, the Notional value turns out to be $10,000. Similarly, the Margin Requirement will be 2%, and the Required Margin will be $200*.

*(Required Margin = $10,000 x 2%)

When the trade is placed, $200 is blocked by the broker as “margin.” And once the position is closed, the complete margin amount (deposit) will be added back to your account balance, given that the trader did not make a loss.

This brings us to the end of this lesson. Let’s see if you can get all the below questions right!

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