It’s very important that the trader gain a good grasp of these two concepts before engaging in any deals, because leverage and margin determine the lifespan of any trading account in a far more decisive manner than either technical or fundamental analysis.
Margin trading is trading with borrowed funds, and is closely related to leveraging. The broker allows the trader to control a far greater amount of money in the market in exchange for a small deposit of funds, with the understanding that the sum borrowed must be returned in exact amount, with any losses or profits returned to the account of client (the trader).
The amount that the client can control is determined by a number called the leverage ratio, and even the occasional observer can notice this number being proclaimed loudly by brokers in the advertisements that they scatter everywhere online. It’s not that difficult to grasp what the leverage ratio does: it simply multiplies the trader’s potential losses and gains in the market by the specified amount. For instance at a leverage ratio of 1/100, the client (you) will be able to control 100,000 USD which makes a standard lot, for a deposit of a mere 1,000 USD, and every single pip gain or loss will be multiplied a hundred times. To put this in a better perspective, you need a movement of just 1% in the price quote before your account is doubled — or wiped out. (Leverage over 50:1 for majors and 20:1 for minors is not available to traders in the U.S.)
One will often come across notices on broker websites making the claim that leverage is a double-edged sword; that you can both lose and gain massively depending on what you do. But high leverage, for sure, is a sword with only one edge, and we will discuss why it is so later.
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