What is Leverage Trading?
Leverage trading, also known as margin trading, is a system which allows the trader to open positions much larger than his own capital. The trader needs only to invest a certain percentage of the position, which is affected by many factors and changes between instruments, brokers and platforms. Leverage trading is popular amongst traders and brokers, and is a common trading system nowadays. “Leverage” usually refers to the ratio between the position value and the investment needed, and “Margin” is the percentage of the position needed.
Why Trade with Leverage
There are several advantages to trading with leverage, so much that is has become a common tool in the trading world.
- Minimizes the capital the trader has to invest. Instead of paying the full price for an instrument, the trader can pay only a small portion of it. for instance – if a position’s value at the time of opening is $3,000; instead of paying the full amount, he can employ a leverage of 400:1 – meaning for every $400 in actual value he will be requested to invest $1 of his own capital. This mean that for this position he will need $7.5 to open it.
- Some instruments are relatively cheap, meaning almost every trader can trade them easily. However, some are considered more prestigious, and based on their traded frequency and other factors are more expensive. Instead of investing large amounts in order to take part in their market, one can use leverage and enjoy the fluctuations in the price of those prestigious instruments.
- While leverage trading, or margin trading, has less capital involved which can be a major advantage for many traders, it also comes with a loss risk. As one can gain much more than his initial investment, losses can occur on the same scale. It is important to keep track of opened positions, and apply stop loss and other market orders in order to prevent large scale losses.
Example of Leverage Trading
For example, the price for one Troy ounce of Gold is $1327. The trader believes the price is going raise, and wishes to open a large buying position for 10 units. The full price for this position will be $13,270, which is not only a large amount to risk, but many traders don’t own such amounts to trade. With a 200:1 leverage offered by AvaTrade, or a 0.50% margin, the amount will decrease substantially. Meaning that for every $200 of worth in the position, the trader will need to invest $1 out of his account, which comes to $66.35 only.
In order to employ leverage, one needs to have sufficient funds in his account to cover possible losses. Each broker has different requirements, and AvaTrade requires the trader has in his Equity at least 10% of his Used Margin for MetaTrader 4 and AvaTradeAct accounts. For AvaOptions accounts, the minimum requirement is 25%.
Going back to the example above, the position’s original value is $13,270; for both MetaTrader 4 and AvaTradeAct accounts, with leverage the trader invested $66.35 of his capital, and if he has 10% of this used margin in equity, i.e. $6.64, his positions will be kept opened. For AvaOptions accounts, with leverage the trader invested $265.40 of his capital, and as long as his net liquidation value remains above 25% of the required margin, i.e. $66.35, his positions will be kept opened.
If, however, the trader has losses and his Equity drops below 10% of used margin on MetaTrader 4 and AvaTradeAct accounts, or 25% on his AvaOptions account, the broker will shut down the client’s position(s), which is called a “Margin Call”. On AvaTradeAct and AvaOptions all the client’s positions will be closed, while MetaTrader 4 will shut down the largest losing position first, and will continue to close positions until the equity level returns above 10% of the used margin.
Leverage Trading with AvaTrade
AvaTrade offers many instruments, and each has a different leverage which can also change based on the chosen platform by the trader. On AvaTradeAct you can enjoy an up to 200:1 leverage, and a 400:1 leverage on MetaTrader4. Most forex pairs have the highest leverage, some metals such as gold are 200:1, crude oil is 100:1 and other metals such as silver and platinum have a 50:1 leverage. It is important to make sure the leverage on the specific platform before you commence you trades, and in order to avoid a margin call always make sure you have enough equity in your account’s balance so you can continue your trades undisturbed.