Leverage and Margin

Leverage and Margin

Leverage allows us to control a larger market exposure with a smaller amount of capital committed as margin. Margin is the collateral or capital requirement supporting that position. These concepts are related, but they are not identical.

Why Leverage Changes Risk

Without leverage, a 2% move in a $5,000 position changes its gross value by $100. With leverage, we may control $5,000 of exposure while committing much less capital. The market still moves against the full exposure, so the percentage change in the margin committed can be much larger.

Margin Is Not a Stop Loss

Margin should never be confused with the maximum amount we can lose. A broker can require additional funds or close a position if available margin becomes insufficient. In a rapidly moving market, liquidation can occur at unfavorable prices.

Practical Example

If we post $1,000 of margin for a position with $5,000 of exposure, the position has 5:1 leverage. A 10% adverse move in the underlying represents a $500 gross loss before costs. That is half of the margin committed, not 10% of it.

Trader Application

We determine leverage from our risk plan rather than from the maximum leverage offered by the broker. Before opening a position, we calculate the economic exposure, the stop or invalidation level, the potential loss and the effect of a gap or rapid move. High leverage does not create an edge; it changes the scale at which an existing edge or mistake affects our account.

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