Margin is money borrowed from a broker to buy more than your own cash would allow. The cash you put up is your equity, and the broker lends the rest against the securities you buy. Leverage is the effect of that borrowing: you control a larger position than your own money would buy, so a given price move produces a bigger gain or loss relative to the cash you put in.
This guide explains how margin accounts work, shows how leverage changes the result with an invented example, describes what a margin call is, and sets out why leverage reduces the room for error. Margin rules, interest and maximum leverage differ by market and broker, so check the terms that apply to your account before you borrow.
What is margin?
Margin is borrowed money that a broker lends so that you can buy more than your own cash would allow. The cash you put up is your equity, and the broker lends the rest against the securities you buy. The broker charges interest for as long as the loan stays open.
Margin accounts also set a maintenance level, which is the minimum equity you must keep relative to the value of the position. If the value falls and your equity drops below that level, the broker can require you to deposit more cash or securities. If you do not, the broker may sell positions without asking you first. Read the margin agreement before you open a position on credit.
How does leverage change the result?
Leverage means that the same price move produces a larger change in your equity, and that works in both directions. The table below uses an invented example with two-to-one leverage, meaning half of the position is borrowed. The figures are illustrative and ignore interest, which would reduce the result in both directions.
| Step | Without leverage | With leverage (2 to 1) |
|---|---|---|
| Your own cash | 1,000 | 1,000 |
| Borrowed amount | 0 | 1,000 |
| Total position | 1,000 | 2,000 |
| Price rises 10% | Position worth 1,100 | Position worth 2,200 |
| Repay the loan | Not needed | 1,000 back to the broker |
| Your equity after a 10% rise | 1,100 (+10%) | 1,200 (+20%) |
| Price falls 10% | Position worth 900 | Position worth 1,800 |
| Your equity after a 10% fall | 900 (−10%) | 800 (−20%) |
A 10 percent move in the market produces a 20 percent move in the account. That doubling is the attraction of leverage, and it is also the danger. A fall of 50 percent in the leveraged position would wipe out all of the equity, while the unleveraged position would still have half its value.
What is a margin call?
A margin call happens when the equity in a margin account falls below the maintenance level set by the broker. The broker can then ask for cash or securities, or sell positions without your agreement. That forced sale can happen at the worst time, even if the market later recovers.
Consider an illustrative position worth 2,000, financed with 1,000 of borrowing. If the position falls 30 percent, it is worth 1,400, and the equity left is 400. If the maintenance level is 30 percent of the position's value, the required equity is 420. Equity of 400 is about 28.6 percent of 1,400, which is below the level, so a margin call would follow.
Why is leverage risky?
Leverage reduces the margin for error, because a modest adverse move can trigger losses or a forced sale. Interest and fees add to the burden each day the loan is open. In a fast market, a price can gap through a stop, so the loss can exceed what was planned.
Leverage also changes behaviour. A trader who has borrowed may hold a losing position longer than they otherwise would, hoping to avoid a margin call, or may add to it, which increases the exposure further. Those responses are the most common route from a manageable loss to a serious one, and they are easier to resist when the rules are decided before the position is opened.
When might leverage be used?
Some traders use leverage to increase exposure to a method they have tested, and some investors borrow to fund purchases. Both uses suit only people who can meet a margin call without selling at a loss. Maximum leverage and margin rules vary by market, product and broker, so check them first.
Before borrowing, write down the most you could lose, including interest, and confirm that you could meet a call from money outside the trade. If that answer is uncomfortable, the position is probably too large for your situation, whatever the expected return looks like on paper.
What should you check before opening a leveraged position?
Check the maintenance level, the interest rate, the maximum loss including interest and the price at which a call would occur. Then confirm where the money for a call would come from. A position that cannot pass these checks is too large, whatever its expected return looks like.
Write the numbers down. The maximum loss is the position size multiplied by the distance to the stop, plus interest and fees, and it should fit within the amount you have decided to lose. The call price is the level at which equity falls to the maintenance requirement, and it should sit well beyond the stop, or the stop is unlikely to protect you.
Plan for a fast market. In a gap, the price can move past both the stop and the call level at once, so a forced sale may happen at a worse price than either. Assume that this can happen, and size the position so that the outcome is still acceptable.
How do you read a margin statement?
A margin statement shows your equity, the value of the positions, the loan and the margin buffer. Read the buffer first, because it tells you how far the market can move before the broker acts. Check the figures each day while a leveraged position is open.
The buffer is the difference between your equity and the maintenance requirement, expressed in money. A shrinking buffer warns of a call before the call arrives, and it is the number to act on. Set a level in advance at which you will reduce the position, rather than waiting for the broker to decide for you.
Common mistakes
Treating borrowed money as your own. Borrowed money carries a claim that must be repaid, whatever the market does. Count the loan as a liability in every calculation.
Ignoring the maintenance level. The level decides when the broker can act. Know the number before you open the position.
Using leverage to recover a loss. Borrowing to win back a loss increases the risk at the moment the account can least afford it.
Checklist
- Read the margin agreement, the maintenance level and the interest rate before you borrow.
- Calculate the maximum loss on the leveraged position, including interest.
- Work out the price level at which a margin call would occur.
- Confirm that you could meet a call from money outside the trade.
- Use a stop, and check how a gap could fill beyond it.
- Keep the leverage well below the maximum the broker allows.
- Review the position daily while it is open, and close it if the margin buffer shrinks.
Key takeaways
Margin lets you borrow to control a larger position, and leverage makes the same price move produce a bigger change in your equity, in both directions. A margin call can force a sale at a poor price, and interest and gaps add to the risk. Leverage is only appropriate when you can meet a call and when the maximum loss is one you have accepted in advance.
This guide is for general information, not financial advice. See the disclaimer.