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What are Financial Leverages?

13 Jan 2023 - Forex Litigation - Min Read 4 min
What are Financial Leverages?

Leverage is the tool that puts the investor in a position to manage larger sums than he has paid into his account.

Forex traders can access large amounts of money in real time, thanks to a mechanism whereby the value of what is invested is made to increase exponentially.

This allows them to make large transactions with minimal capital, as Forex has turned out to be a democratic market, which allows even the small saver to invest.

The levers that are favored in Forex are those ranging from 1:50 to 1:200. The most widely used leverage, however, is the 1:100.

Thanks to leverage, minimal investments can bring huge gains over time if a series of fortunate circumstances occur, but it could also lead to a sudden loss of all capital.

Hypothetically, by depositing a minimum amount of 100 euros, with a leverage of 1:100, each euro produces its own profit of 100 euros. Thus, by opening a position and obtaining a profit of 1, thanks to the leverage 100 euros will be gained.

This means that a movement of 1% can produce a profit of 100%, but also a loss equal to the amount initially invested.

In online trading, 1% can move in no time at all and, if you are below capital on it, you can see investments disappear immediately.

The Margin Call

When you use leverage, the amount that the trader deposits is considered a “Margin”, that is to say a guarantee that serves to cover the display relative to the position that it wants to open up.

The “Margin Call” serves as a warning when the account is about to go negative by preventing this from happening. The margin always represents the initial balance, and not the one to be used.

Margin is a requirement that the broker asks to cover any losses. Before the entire principal goes up in smoke, brokers are required to alert traders through a Margin Call.

A margin call is a notification sent by the broker to an investor using leverage, with the goal of requesting more funds in his or her account. This occurs when the financial asset one has acquired faces a collapse that prevents one from meeting the minimum margin deposit imposed by said broker.

Often the English expression “margin call” is used, basically it is triggered in a trading account and the trader is called upon to integrate a security amount to prevent his open positions in the financial markets from being closed.

When the account balance falls below the margin requirement to keep the position open, a margin call is triggered, and the trader is notified to avert the risk by depositing more money or to knowingly agree to close the position.

Each broker has its own margin management, the details of which are specified in the contract terms.

We recommend that you always read these terms carefully, as it is also stipulated there how the broker intends to communicate the achievement of margin (via e-mail, phone call, messaging app, text message …).

How does a financial leverage work?

To better understand the working mechanism of a lever, we can hypothesize what would happen to a €1,000 investment in the presence of leverage.

If, to make a practical example, €1,000 were transferred into the account, thanks to leverage of 1:100 you could have under your control an amount of capital of €100,000.

With these requirements the trader can theoretically open a maximum of one standard lot. It is a shame that the margin employed would be equal to 1,000, but with its available equity equal to 0.

Equity of this type would not make it possible to cover losses, therefore the broker could never authorize the opening of a similar position.

It would be more plausible, in similar circumstances, to open a position with 0.5 lots. The margin employed would be equal to half the figure, and the other half would coincide with the equity.

Positions remain open to a loss limit of 100PIPs, in the case in question, equalling €500.

The loss of €500 would get the Margin Call process started, that is to explain that the warning on the part of the broker that if more funds were not added, the positions would have to be closed, otherwise it would be done automatically, starting with the less useful ones. The Margin Call could be fixed at 30% of capital whilst at 20% a

Stop Out Level (closure of positions) would come about, and the definitive loss of the entire amount transferred or of the part used.

If, instead of 100 PIPs, 70 of them are lost, equity that has fallen to €150 would make a Margin Call spring into action.

If equity hardly reaches €100 one has the Stop Out Level and the losses stop at €400 whilst the available equity ends up as €600.

What would a professional trader do? 

Professional Forex traders are used to trading with leverage of 1:2, starting with large deposits.

Therefore, if brokers consent to leverage up to 1:400 it is never advisable to open an account with small deposits, because the risk increases, and because it appears that the under-funding could lead to the failure of well-prepared traders as well.

If you have been involved in a scam linked to Forex or suspect that your broker is acting in a shady manner, do not hesitate to contact our expert Forex Lawyers.

The Forex Litigation Department will clarify any doubt you may have and will suggest the best way to safeguard your investments.

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Calogero Boccadutri

Calogero Boccadutri is the Managing Partner of Boccadutri International Law Firm. He has trial experience in Forex, Personal Injury and Administrative litigation.

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