Indices Trading Leverage & Margin Trading Explanation & Examples
Margin required : It's amount of money your indices broker requires from you to open a position. It is expressed in percents.
Equity : It's the total amount of capital you have in your account.
Used margin : amount of money in your trading account which has already been used up when buying a indices trading contract, this contract is the one that is displayed in open positions. As a trader you can't use this amount of money after opening a trade because you've already used it & it isn't available to you.
In other words, because your indices broker has opened up a position for you using the capital you have borrowed, you must maintain this usable margin for your trading account as a security to allow you to continue using this indices leverage he has given you.
Free margin : amount in your account that you can use to open new trades. This is amount of money in your account which has not yet been indices trading leveraged because you have not yet opened a trade with this money - this is also very important for you as a trader because it enables you to continue holding your open trade transactions as explained and illustrated below.
However, if you over use stock indices trading leverage, this free margin will drop below a certain percent at which your stock indices broker will have to close all your positions automatically, leaving you with a big loss. Index broker at this point automatically closes all your open trade position because if your trade positions are left open broker would lose the money you'll have borrowed from them.
This is why you should always make sure you've a lot of free margin. To do this never trade more than 5 percent of your stock indices account, in fact 2 percent is recommended.
Difference Between Stock Indices Trading Leverage Set by Broker & Used Indices Trading Leverage
If the set stock index leverage is 100: 1, it means you can borrow up to 100 dollars for every 1 dollar you have, but you don't have to borrow all of the 100 dollars for every 1 dollar you have, but you can decide to borrow 50:1 or 20:1. In this case even though the leverage ratio option set 100:1 your used indices trading leverage will be the 50:1 or 20:1 that you have borrowed to make a trade.
Example:
You have 1000 dollars (Equity)
Set 100:1
Indices Leverage Used = Amount used /Equity
If you buy index lots equal to 100,000 dollars that as a trader you will have used
= 100,000/1000
= 100:1
If you buy indices lots equal to 50,000 dollars that you will have used
= 50,000/1000
= 50:1
If you buy indices lots equal to 20,000 dollars that you will have used
= 20,000/1000
= 20:1
In these 3 cases you can see that even though the set is 100:1
Used is 100:1, 50:1, 20:1 depending on size of indices lots traded.
So Why not Just Select 10:1 option as the Maximum Indices Leverage? Because to keep within the proper risk management rules it is even recommended that traders use less than this?
This question may seem straight forward but it is not, because when you trade you use borrowed money known A.K.A. Indices Trading Leverage. When you borrow capital from anyone or a bank you must maintain security or collateral to acquire a loan, even if the security is based on monthly deduction from your salary, same thing with Indices Trading.
In indices trading the security is known as margin. This is the capital you deposit with your broker.
This is calculated in realtime as you trade. To keep your borrowed money you must maintain what is known as the required capital (your deposit).
Now if Your Stock Indices Trading Leverage is 100:1
When trading if you have $1,000 & use option 100:1 & buy 1 standard lot for $100,000 your margin on this transaction is $1000 dollars in your account, this is the money that you will lose if your open trade goes against you the other $99,000 that is borrowed, they will close the open indices trade transactions automatically once your $1,000 has been taken by stock indices trading market.
But this is if your indices broker has set 0% Indices Margin Requirement before closing your stock indices trades automatically.
For 20% requirement before closing your stock indices trades automatically, then your trades will be closed once your account balance gets to $200
For 50% requirement of this level before closing your stock indices trades automatically, then your trades will be closed out once your trade account balance gets to $500
If they set 100% requirement of this level before closing your open positions automatically, then your trade will be closed once your account balance gets to $1,000: Explanation the trade will close-out as soon as you execute it because even if you pay 1 pips spread your account balance will get to $990 and the needed percent is 100% i.e. 1,000 dollars, therefore your orders will immediately get closedout.
Most brokers do not set 100% requirement, but there are those who set 100% are not suitable for you at all, select those set 50% or 20% margin requirements, in fact, those indices brokers that set at 20% are some of the best because the likely hood they close-out your trade is reduced as displayed in example above.
To know about this level which is calculated by your trading platform automatically - MetaTrader 4 Indices Trading Platform will display this as "Indices Margin Requirement", This will be displayed as a percent higher the percent the less likely your trades are to get closed.
For Example if
Using 100:1
If stock indices leverage is 100:1 and you transact indices lots equal to $10,000
$10,000 dollars divide by 100:1, used capital is $100
Calculation:
= Capital Used * Percentage(100)
= $1,000/$100 * Percentage(100)
Indices Margin Requirement = 1,000 %
Investor has 980% above required amount
Using 10:1
If stock indices leverage is 10:1 and you transact indices lots equal to $10,000
$10,000 dollars divide by 10:1, used capital is $1000
Calculation:
= Capital Used * Percentage(100)
= $1,000/$1000 * Percent(100)
Indices Trading Margin Requirement = 100 %
Investor has 80% above required amount
Because when a trader has a higher indices leverage means that they have more percentage above what is required(A.K.A. More "Free Indices Trading Margin") their open indices trading transactions are less likely to get closed. This is reason why traders will choose option 100:1 for their trading account but according to their risk management rules, these traders will not trade above 5:1.
These Levels are Shown on the Software Image Below as an Examples:
MetaTrader 4 Stock Indices Software
