Confusion about leverage

[flizzoe]

Hi there,

I'm quite confuse on how leverage works. I read the definitions of leverage and margin here:
Leverage: Leverage - Traderpedia
Margin: Margin - Traderpedia

and there's borrowed funds or loan from the broker.

How does this actually work? I mean, if I lost all my money, why don't I need to repay my broker back, since I was using leverage, and that's mean I borrowed money from the broker to trade.

Anybody can clarify this? Thank you in advance.

 

[arabianights]

You would have to pay the broker back if you lost a lot of money.

Say the broker lends you X, and you contribute Y.

So with a leveraged account, you can buy X+Y worth of an instrument.

If the instrument then loses 2Y, you will owe the broker Y pounds.

If it loses 0.5Y then you don't owe the broker anything, but you have lost half your capital.

If X = 10Y, then an increase in the instrument's price from 11Y to 12Y means that you have doubled your money with an instruement that has appreciated less than 10%. This is the beauty of leverage.

Some derivatives are enormously leveraged. Technically, at the moment I'm typing this I have about £50 million of nominal value instruments which I'm intending to make around £2000 on today. The nominal value of all derviatives in existance is many, many times World GDP.

 

[flizzoe]

You would have to pay the broker back if you lost a lot of money.

Say the broker lends you X, and you contribute Y.

So with a leveraged account, you can buy X+Y worth of an instrument.

If the instrument then loses 2Y, you will owe the broker Y pounds.

If it loses 0.5Y then you don't owe the broker anything, but you have lost half your capital.

If X = 10Y, then an increase in the instrument's price from 11Y to 12Y means that you have doubled your money with an instruement that has appreciated less than 10%. This is the beauty of leverage.

Some derivatives are enormously leveraged. Technically, at the moment I'm typing this I have about £50 million of nominal value instruments which I'm intending to make around £2000 on today. The nominal value of all derviatives in existance is many, many times World GDP.

Thanks, that is what I'm thinking.

But I never asked by my broker to pay back. I trade Forex. Whenever I lost my money, there will be "margin call" and my account will be zero.

And still I didn't need to pay anything to my broker. How come?:?:

 

[arabianights]

Thanks, that is what I'm thinking.

But I never asked by my broker to pay back. I trade Forex. Whenever I lost my money, there will be "margin call" and my account will be zero.

And still I didn't need to pay anything to my broker. How come?:?:

Presumably your broker closed out the positions before (or at) when the account went to zero.

If they were unable to do that and your account went negative, you would owe them money.

The purpose of margin AKA haircut in the first place is to try and ensure that this doesn't happen. This works 99% of the time, for when it doesn't see LTCM et al.

 

[theroguetrader]

Hi there,

I'm quite confuse on how leverage works. I read the definitions of leverage and margin here:
Leverage: Leverage - Traderpedia
Margin: Margin - Traderpedia

and there's borrowed funds or loan from the broker.

How does this actually work? I mean, if I lost all my money, why don't I need to repay my broker back, since I was using leverage, and that's mean I borrowed money from the broker to trade.

Anybody can clarify this? Thank you in advance.

MARGIN - refers to borrowing capacity
if your trading on a margin account,the profits and losses are taken from your account in real time - (marked to market)
If your running losses EXCEED the cash you have in your account - you will have to add funds to your account to cover the losses

The MORE your leveraged, the MORE those losses (or profits) are MAGNIFIED .... !!

NEVER pay a margin call -(essentially your just funding a LOSS and the more you fund it,the BIGGER it will get)..!! - A small loss is ALWAYS easier to take than A BIG ONE..!!


LEVERAGE - is a word that should always be written in RED.. !! - Its like a DOUBLE EDGED sword.. !! VERY dangerous - !!
Used correctly and handled with care, it can help make you wealthy beyond your wildest dreams - slip up, and fall on it BADLY - (back to the drawing board).. !!

 

[flizzoe]

okie, I got more confused.

Let say I'm trading in a standard account, 1 lot = 100,00 with leverage 1:500.

If I trade 1 lot of USD/JPY, the cost is $100,000. But because of the leverage, I only need to pay $200. Does that mean my broker lend me the rest? ($100,000 - $200 = $98,800)

Can someone explain. Thank you in advance.

 

[arabianights]

okie, I got more confused.

Let say I'm trading in a standard account, 1 lot = 100,00 with leverage 1:500.

If I trade 1 lot of USD/JPY, the cost is $100,000. But because of the leverage, I only need to pay $200. Does that mean my broker lend me the rest? ($100,000 - $200 = $98,800)

Can someone explain. Thank you in advance.

Nominally, yes. If the dollar becomes completely worthless in a second, then you'll owe your broker $100 000 (not that it matters, because the dollar is... worthless).

 

[Rhody Trader]

If I trade 1 lot of USD/JPY, the cost is $100,000. But because of the leverage, I only need to pay $200. Does that mean my broker lend me the rest? ($100,000 - $200 = $98,800)

The answer is NO.The forex market operates like futures, not like stocks.

In stocks when you trade on margin it means you borrow money from your broker. When the trade is done you have to pay the broker back. You also get charged interest on the loan amount.

In futures you are trading in agreements (contracts), not in actual assets. The margin you put up is a surety against the market moving against you to protect the system against you defaulting on your commitments. At no point do you borrow money from anyone.

The forex market operates the same way. You are not actually exchanging currency when you trade. Technically you are entering into a 2-day forward agreement to do so - like a short-term futures contract. Unlike in futures though, where you could actually end up in a delivery situation if you didn't offset your position, in forex your broker basically rolls your position forward at the close each day (if you have an open trade).

 

[arabianights]

The answer is NO.The forex market operates like futures, not like stocks.

In stocks when you trade on margin it means you borrow money from your broker. When the trade is done you have to pay the broker back. You also get charged interest on the loan amount.

In futures you are trading in agreements (contracts), not in actual assets. The margin you put up is a surety against the market moving against you to protect the system against you defaulting on your commitments. At no point do you borrow money from anyone.

The forex market operates the same way. You are not actually exchanging currency when you trade. Technically you are entering into a 2-day forward agreement to do so - like a short-term futures contract. Unlike in futures though, where you could actually end up in a delivery situation if you didn't offset your position, in forex your broker basically rolls your position forward at the close each day (if you have an open trade).

But if the market shoots through the margin before the broker can close the trades then he will owe his broker money.

 

[theroguetrader]

But if the market shoots through the margin before the broker can close the trades then he will owe his broker money.

yip...... PERFECTLY explained...... !!

 

[Trojen]

Hi there,

I'm quite confuse on how leverage works. I read the definitions of leverage and margin here:
Leverage: Leverage - Traderpedia
Margin: Margin - Traderpedia

and there's borrowed funds or loan from the broker.

How does this actually work? I mean, if I lost all my money, why don't I need to repay my broker back, since I was using leverage, and that's mean I borrowed money from the broker to trade.

Anybody can clarify this? Thank you in advance.

I battled with this in the begining. This is how I got my head around it.

Margin is your DEPOSIT to play the game. I see leverage as how much bang are you going to get for your cash, or your cash per point. In the traders game it's more about points won or lost. Ask yourself, "how much EXPOSURE does this DEPOSIT get me into?" That EXPOSURE is your total risk.

 

[theroguetrader]

I battled with this in the begining. This is how I got my head around it.

Margin is your DEPOSIT to play the game. I see leverage as how much bang are you going to get for your cash, or your cash per point. In the traders game it's more about points won or lost. Ask yourself, "how much EXPOSURE does this DEPOSIT get me into?" That EXPOSURE is your total risk.

no - Margin is MARGIN /(performance bond in the US)
DEPOSIT- is an NTR- (Notional Trading Requirement)

they are two different things -

 

[flizzoe]

The answer is NO.The forex market operates like futures, not like stocks.

In stocks when you trade on margin it means you borrow money from your broker. When the trade is done you have to pay the broker back. You also get charged interest on the loan amount.

In futures you are trading in agreements (contracts), not in actual assets. The margin you put up is a surety against the market moving against you to protect the system against you defaulting on your commitments. At no point do you borrow money from anyone.

The forex market operates the same way. You are not actually exchanging currency when you trade. Technically you are entering into a 2-day forward agreement to do so - like a short-term futures contract. Unlike in futures though, where you could actually end up in a delivery situation if you didn't offset your position, in forex your broker basically rolls your position forward at the close each day (if you have an open trade).

okie.. this is what I understand, and let me show new calculation, you said, traders are trading in agreements, so, is it like:

I'm trading a standard account, the cost for 1 lot is $100,000 with 1:500 as leverage.

By the virtue of leverage, my broker would let me to have that 1 lot contract (just as you said) with only $200 for USD/JPY with the pips value according to the current price. The broker also charge you "spread" to pay the cost of the contract.

Is it like, my broker is actually selling cheap stuff to me?

 

[Rhody Trader]

I'm trading a standard account, the cost for 1 lot is $100,000 with 1:500 as leverage.

By the virtue of leverage, my broker would let me to have that 1 lot contract (just as you said) with only $200 for USD/JPY with the pips value according to the current price. The broker also charge you "spread" to pay the cost of the contract.

Is it like, my broker is actually selling cheap stuff to me?

I have no idea what you mean about selling you cheap stuff.

And your broker doesn't charge you the spread. The spread is nothing more the the difference between the bid and the offer. It's not as though your broker takes that money out of your cash balance like a commission.

 

[flizzoe]

I have no idea what you mean about selling you cheap stuff.

And your broker doesn't charge you the spread. The spread is nothing more the the difference between the bid and the offer. It's not as though your broker takes that money out of your cash balance like a commission.

erm..
well.. to have a $100,000 contract and pay only $200, doesn't that mean cheap?
or i misunderstood everything (again?)?

 

[flizzoe]

another question:

If spread is just the difference between bid and ask, and broker does not take anything from that, how does actually broker make money?

and,

When I trade 1 lot, is it actually $100,000 or 100,000 unit of that currency?

Before this I only learn technical analysis, I didn't care about how this thing actually works. But now I'm really curious about it.

Thank you in advance for any clarification

 

[Trojen]

no - Margin is MARGIN /(performance bond in the US)
DEPOSIT- is an NTR- (Notional Trading Requirement)

they are two different things -

I am using these terms to explain concepts in "First steps", not a "glossary" section.....capish???? {taps side of head repeatedly}

 

[Rhody Trader]

erm..
well.. to have a $100,000 contract and pay only $200, doesn't that mean cheap?
or i misunderstood everything (again?)?

I'm not entirely sure how you're understanding things. You are not paying $200 for something worth $100k. You are putting down a surety deposit against any losses you might incur while controlling that position.

 

[Rhody Trader]

If spread is just the difference between bid and ask, and broker does not take anything from that, how does actually broker make money?

The broker (assuming it's a market maker and not an ECN - which charges commissions) does derive its profits from the spread. But it does so by buying at the bid and selling at the offer repeatedly. If you buy a lot of USD/JPY, you will do so at the offer price. Meanwhile, someone else is probably selling a lot of USD/JPY at the bid simultaneously (or close enough). The broker then just made the spread. That's how they work, and how all market makers work in all markets at the base of things.

When I trade 1 lot, is it actually $100,000 or 100,000 unit of that currency?

It is 100,000 units of the base currency in the pair (first one listed). New traders get this one wrong all the time when they are trying to figure out their margin requirements.

 

[flizzoe]

I'm not entirely sure how you're understanding things. You are not paying $200 for something worth $100k. You are putting down a surety deposit against any losses you might incur while controlling that position.

Now that explain something, do you mind explain and illustrate further? (I'm sorry if my request is burdensome, it's just somehow many people have wrong perception on this matter, including me)

And, how to differentiate a market maker with an ECN?

Add some more:
This is what I understand, when I open a position, I actually have control on that position, but I don't own that position. If I lost, and choose to close the position, then it will be deducted from the $200 (1 lot of USD/JPY). Am it right?