Margin and Leverage in Forex Trading: Balancing Risk and Rewards

When you step into Forex trading, you must understand two rudimentary concepts: 

Margin and Leverage. The concept between Margin and Leverage in Forex trading is simple to understand.

In a nutshell, the capital borrowed from an investor to trade in a larger position in Forex is called Margin, and the use of this capital or borrowed money is called leverage. Moreover, these trading terms may sound the same to you. However, there is much to know about them. MT4 platform provides a great margin calculation tool that helps traders to determine the required margins.

There is another term called the Risk and Reward ratio, which is another forex trading strategy. Let’s dive into the next phase of our article without further ado.

What is Margin?

Margin in forex trading is a term in which the investor borrows or takes a loan from a broker, which is used for executing trades. Furthermore, the investor must open a margin account and make a small primary investment to trade on Margin. This invested amount is called margin value, and the capital or funds in the margin account is called maintenance margin.

The sum invested proceeds as leverage and is known as the minimum Margin. This leverage amplifies both gains and losses. In case of a loss or the sum value falls the broker can liquidate the securities without any notice. This liquidating practice is called a margin call.

What is Leverage?

It is a very common phrase in forex trading. As mentioned, the capital or money borrowed from the broker is used for trades. This borrowed money allows traders to invest in a larger position. The leverage can also be called purchasing power, provided by the brokers to investors to trade a larger amount.

As the forex markets don’t move fast compared to stocks, brokers provide you with leverage to increase your capital for higher profits. We can understand this from his ratio of 1:500, which means if the investor has $1 in his/her account, they can open trades worth $500.

The leverage system is a double edge sword; it either maximizes your profit or loss. There is nothing in between.

Difference Between Margin and Leverage

The Margin and the Leverage are correlated but have different concepts and meanings. Furthermore, the amount needed to open a trade for a certain position is known as Margin. In contrast, investors can start a trade with a smaller amount of leverage.

The leverage depends on the forex margin, which guides the investors about the trade value required to open a trade. If the forex margin is 4.4%, the leverage ratio is 40:1. So, an investor with $3,000 to open a trade can easily trade at $120,000 (if the leverage ratio is 40:1).

In addition, traders must know the benefits and drawbacks of leverage. It can be both risky and profitable at the same time.

Risk Reward Ratio in Forex

In sum, the risk-reward ratio is the risk you take for a reward. This strategy plays a vital role in professional trading. Let’s suppose you are BUY trading in GBP/USD. The entry point is 1.4555, while the stop loss is also 1.4555, and you are taking the risk of 50 pips. It means the risk-reward ratio is 1:1, 1% risk, and 1% reward. There is no loss and gain in this risk-reward ratio. 

Traders utilize the risk-reward ratio in Forex to identify whether the trade is worthy or not. Trading in pairs with a high chance of a positive risk-reward ratio is recommended. 

Conclusion

Forex trading depends on strategies and how traders utilize them for their profits. Leverage and Margin are two basic terms to know before entering forex trading. In addition, it is also important for you to learn the risk-reward ratio strategy for professional trading.