Difference between Margin and Leverage
There are so many traders in the stock market who have good knowledge and understanding of the market but they lack funds while trading, many time they know that a certain stock will perform according to their prediction, its movement will be the same as they thought but what they could do as the big factor is money.
To resolve this issue of the traders, there are facilities like margin and leverage, traders are using these facilities too but many of them got confused when they read phrases like “difference between margin and leverage” and it is because they think that both of these terms have the same meaning.
So, let us discuss what these terms are before we discuss the difference between them.
What is Margin and Leverage in trading
Let’s say, there is a stock whose current market price is 200 rupees and you get this strong feeling that this stock will surely go up today by approx. 20 rupees as your prediction is based on good technical analysis.
But in your trading account, you only have 5000 Rs. and if you will trade with those 5000 rupees you could buy 25 shares (Rs. 5000/ Rs.200) and at the end of the movement of that stock, your profit would be 500 rupees (25 shares * 20 rupees profit per share).
You’re thinking that, If I could buy 100 shares then my profit would be 2000 rupees (100 shares * 20 rupees profit per share) but you need extra 15,000 rupees to buy those extra 75 shares which you can’t do because you don’t have that money.
In the situation we mentioned above, your broker can give you money to trade intraday but the broker put some conditions over the amount of money that it gives you and these conditions are nothing other than margin and leverage.
Whatever the amount you want to trade the desired quantity of shares of any particular stock, the broker wants to have some part of that amount, which you want to borrow, in your trading account. Let’s say the broker is demanding that you should’ve 25% of the amount which you want to borrow from us.
Here, in the aforesaid example, you need Rs. 20,000 and you’ve 5000 rupees in your trading account which means you’ve 25% of the money you want from your broker and we can also say that you want to borrow 4 times (4x) the money which you have.
The margin is the percentage of the money (which you want to borrow from your broker) that the broker wants to have with you. Here, 25% is the margin.
And the leverage is the number of times the money (which you’ve in your trading account) that the broker is ready to give you for your trade. Here, 4x is the leverage.
What is the Margin in trading
Margin is the minimum amount required in your account to start a trade i.e. It is the fraction of money that a trader must have in his account to open a position.
It is expressed in percentages.
It means that if the margin is 20% then you must have 20% of the amount which you want to borrow from the broker.
What is Leverage in trading
Leverage is nothing but a facility that a broker provides to its customers to trade with more money than the trader has.
It is expressed as a ratio but generally, you see leverage in the form of “how many times”.
It means that if the leverage is 5x i.e. 5:1 (in ratio) then if you’ve 1 rupee in your trading account you can trade up to 5 rupees, as the broker is lending you extra 4 rupees.
Difference between Margin and Leverage
Margin is a fraction of money that a trader must have in his trading account to open a position
Leverage is the facility provided by the broker to traders where the latter ones can trade using more capital than they have in their trading account
It is expressed in percentage
It is expresses in ratio
You use margin to create leverage i.e., margin is the amount of money that need to be maintained to avail leverage
Leverage is derived from margin
E.g. 20%, 35%, etc.
E.g. 3:1 (3x), 5:1 (5x)
Margin and leverage example
You can see that the margin and leverage are different for the IDEA stock than the 3MINDIA stock.
Doesn’t it mean that the margin and leverage are pre-defined for the stocks?
It means that if you have those 5000 rupees and if you want to trade the IDEA stock, your broker is ready to give you Rs.15,000 (3 times the money you’ve i.e. 5000) but if you decide to trade the 3MINDIA stock, your broker is now giving you Rs.20,000 as here the leverage is 4x.
So, it depends on stock-to-stock that how much margin and leverage would you get and also on your broker as some brokers provide you less margin on a particular stock while the others give you a high margin on that same stock.
How does leverage affect margin?
Margin and leverage are related to each other. So, you can say that leverage affects the margin of any given stock and the margin can also affect the leverage for that stock.
The relation between margin and leverage is…
How to calculate margin and leverage
If you have this question in your mind, how can you calculate margin and leverage for the stock you trade then let me tell you that there is no such need as the margin and leverage for each stock are pre-defined.
But, if you want to know how can you derive margin from leverage and leverage from margin then have a look at this calculation:
Most people use the terms margin and leverage interchangeably but it is not correct both have different meanings. Margin is expressed in percentage while leverage is expressed in a ratio.
You can say that margin and leverage are interrelated by the formula “Margin ∝ 1/Leverage” as if margin will increase then the leverage will decrease and the interpretation is that if the required margin is high then surely the broker is giving you lesser leverage.
You need to have a margin account if you want to trade in the margin.