Have you ever felt like you’re trying to grow a beautiful garden with just a single withered seed? Welcome to the world of CFD trading! But here’s a fun fact: if you partner with a reliable and respected broker, you’ll be given a powerful growth serum—even if your initial resources are scant.
Indeed, that one withered seed can potentially blossom into a thriving orchard through the magic of two powerful forces: margin and leverage.
Octa Broker, which has been providing retail traders with reliable access to financial markets since 2011, explains the superpower of these two instruments, which are actually quite simple even if they sound a bit intimidating.
Leverage
Leverage is like a powerful gardening tool for traders. If you want to plant a magnificent oak tree, but you only have a single seed to start with, the chances of that one seed surviving and growing into a huge tree on its own are slim. However, in the world of CFD trading, your broker is like a master gardener ready to give you all the resources you need to cultivate a thousand seeds instead of just one. All you have to do is provide a single seed as the initial capital.
This is the essence of leverage. It allows you to control a much larger investment than your initial capital. In our tree example, if the broker gives you the resources to manage 1,000 seeds with your one, that’s a leverage ratio of 1:1000. For every one seed you provide, you can tap into the potential of a thousand.
Leverage is an essential tool in the world of currencies trading. That is because the size of a single standard lot in the market is a whopping 100,000 units of base currency. For example, to open a 1-lot position in EUR/USD on an EUR-denominated account with 1:1 leverage, a trader would need at least 100,000 euros just to enter the trade, while a micro lot position of 0.01 would require 1,000 euros. In other words, without leverage, the market entry cost becomes prohibitively expensive. Octa Broker provides leverage of up to 1:1000, allowing traders to enter the market using minimal resources and reduced capital.
Margin
Some traders, especially those with experience in trading stocks, find the concept of margin in currencies trading to be somewhat confusing. This stands to reason, for the term is used differently in the currency market compared to its traditional meaning in other financial sectors. Indeed, there are fundamental differences in how the concept functions, leading to misconceptions about what margin truly represents.
In stock trading, margin involves explicitly borrowing money from a broker to purchase securities. A trader pays interest on the borrowed money and puts up collateral with the broker in a special margin account. Cash deposit or actual securities already in the account can be used as collateral for a loan. If the value of the securities used as collateral for the margin loan falls below the minimum equity maintenance requirement, a trader’s account may incur a ‘margin call’. This term means a request by the broker to deposit more funds or sell securities to meet the collateral requirements.
In currencies trading, margin is a kind of ‘good-faith deposit’ set aside from a trader’s account to open and maintain a leveraged position. Remember, when we talked about leverage, we said that the market entry cost would have been too high without it. Well, that market entry cost is, in fact, what is called margin in currencies trading. For example, with a 1:1 leveraged account (which essentially means no leverage used), a margin requirement to initiate a standard 1-lot position in EURUSD would equal 100,000 euro, while a 0.01 lot position would require a margin (or a deposit) of 1,000 euro.
The table below illustrates the capital required to trade the EURUSD currency pair based on different position sizes and leverage levels for a euro-denominated account. You can use Octa’s trading calculator to determine the required margin for other financial instruments.
Table: An example of capital requirements or required margin (displayed in euro) for a EURUSD currency pair based on the lot size and leverage
Source: Octa Broker
In the currencies market—contrary to stock trading—margin is not a loan on which a trader pays interest, but a cash deposit to cover potential losses. However, here, too, a margin call may occur if a trader’s account equity drops below a certain level (often 80-90% of used margin).
As for the leverage, it is equally not a loan. It is simply a tool, which allows traders to ‘leverage’ their money to a greater extent with the broker’s help, without actually borrowing more money. Octa Broker provides leverage of up to 1:1000, allowing traders to enter the market using minimal resources and reduced capital.
Important Glossary
OctaTrader, Octa’s proprietary trading platform, provides real-time updates on a trading account’s total margin usage. The platform continuously adjusts the trader’s balance to reflect the current profits and losses, allowing the trader to always see the available leverage. This feature enables monitoring the risk level at any moment, helping determine if a trader has enough room to make new trades or if he or she is approaching a dangerous level of exposure. The following indicators are always on display in every trader’s account on OctaTrader:
- Margin is the amount of money you must deposit and keep in your account to open and maintain a leveraged position.
- Free margin is the amount of money in your trading account that isn’t currently being used as margin for open trades. It’s the available capital you can use to open new positions or to absorb potential losses on your current trades. It’s calculated as:
[Free Margin = Equity – Margin]
- Margin level is a key risk indicator that shows the health of your trading account. It’s expressed as a percentage and is the ratio of your equity to your margin.
[Margin Level = (Equity / Margin) * 100%]
A high margin level means you have plenty of free capital, while a low margin level indicates that your account is at a higher risk of a margin call or stop-out.
- Equity is the real-time value of your trading account. It represents your total capital, including your initial deposit, profits or losses from closed trades, and the floating PnL (see below) from your currently open positions. It is the amount of money you would have if you were to close all your open trades at that exact moment.
[Equity = Account Balance + Floating PnL]
- Floating PnL (Profit and Loss), also known as unrealised PnL, is the profit or loss from your open positions. It is “floating” because it changes constantly with market prices and is not officially yours until you close the trade. Once you close the position, the floating PnL is added to or subtracted from your account balance and becomes realized PnL.
