Introduction
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 marginin 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
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.
Disclaimer: This article does not contain or
constitute investment advice or recommendations and does not consider your
investment objectives, financial situation, or needs. Any actions taken based
on this content are at your sole discretion and risk—Octa does not accept any
liability for any resulting losses or consequences.
About Octa
Octa
is an international broker that has been providing online trading services
worldwide since 2011. It offers commission-free access to financial markets and
various services used by clients from 180 countries who have opened more than
61 million trading accounts. To help its clients reach their investment goals,
Octa offers free educational webinars, articles, and analytical tools.
The
company is involved in a comprehensive network of charitable and humanitarian
initiatives, including improving educational infrastructure and funding
short-notice relief projects to support local communities.
Since
its foundation, Octa has won more than 100 awards, including the ‘Most Reliable
Broker Global 2024’ award from Global Forex Awards and the ‘Best Mobile Trading
Platform 2024’ award from Global Brand Magazine.
This article was written by IL Contributors at investinglive.com.