How Markets Work · Intermediate · 5 min

Leverage and margin: the mechanics

You can calculate how leverage changes the result of a price move, explain margin and margin calls, and describe the EU limits for retail CFDs.

A magnifying glass

Many trading apps show it in large letters: trade with 1,000 and control 30,000. Leverage sounds like a shortcut to bigger results with less money.

It is better to think of it as a magnifying glass. It makes every move of the price larger, in your favor and against you. Understanding the mechanics before using it is not optional. It is the difference between a manageable loss and losing everything in one bad afternoon.

Position, deposit, margin

Leverage means your position is larger than the money you put down. That money is the margin: a deposit the broker holds while the position is open.

At leverage 10:1, a deposit of 1,000 controls a position of 10,000.
Every 1% move in the price is 100, which is 10% of your deposit.
A 5% move against you is 500, half of your deposit.

The price move is the same at every leverage. Only its effect on your money changes. At 30:1, a fall of just over 3% is enough to wipe out the whole deposit.

Brokers set a minimum margin you must keep. If losses push your account below it, you get a margin call: pay in more money, or the position is closed. The SEC warns that your broker may sell your holdings at any time without consulting you first, and does not have to wait for you to respond. Closing happens at the next available price, so in a gap the loss can be larger than planned.

In the EU, ESMA introduced binding rules for retail CFDs in 2018, which national regulators later made permanent:

leverage limits from 30:1 for major currency pairs down to 2:1 for crypto assets,
a margin close-out once your margin falls to half of the required minimum,
negative balance protection, so your loss is limited to the money in your CFD account.

Outside these rules, for example with some futures or offers from outside the EU, losses can exceed your deposit. The SEC notes this for retail forex trading too.

Half gone in one move

You deposit 1,000 and open a long CFD position on a fictional index worth 10,000, leverage 10:1.

The index falls 5%. Your position is now worth 9,500. You have lost 500, half your deposit.
Your broker requires a minimum margin. With only 500 left, you are close to it.
The next morning the index opens another 3% lower. The broker closes your position.

A fall of just under 8% in the index has cost you 785, almost 80% of your money. Without leverage, the same 1,000 invested directly would have lost about 79.

Common mistakes

Looking at the price move, not the deposit. A 2% move at 20:1 is 40% of your money.
Using the maximum leverage offered. A limit is not a recommendation.
Counting on a margin call warning. Brokers may close positions without asking you first.
Assuming losses stop at the deposit. Only certain products and rules give you that floor.

The takeaway

Leverage lets a small deposit control a large position. A small move against you becomes a large loss, and the broker can close you out.

Check yourself

Quick quiz

4 questions. Instant feedback, nothing is saved.

1Tap the leverage at which a 5% fall wipes out half of the deposit.

Tap the chart.

At 10:1, a 5% move in the price is a 50% move in your deposit: 5 × 10 = 50.
2You deposit 1,000 and open a position of 10,000. The price falls 5%. What is your loss?

5% of the 10,000 position is 500. Measured against your 1,000 deposit, that is a loss of 50%.
3What can your broker do if your margin falls below its requirement?

The SEC warns that brokers may sell securities in a margin account at any time, without consulting you first.
4What is the highest leverage for retail CFDs on major currency pairs under the EU rules ESMA introduced in 2018?

ESMA set limits from 30:1 for major currency pairs down to 2:1 for crypto assets. National regulators later made these limits permanent.

of 4 correct.