Leverage and margin: how much of the trade is yours

Two people open an account with the same broker and the same 1:100 leverage on EUR/USD. The first deposits KSh 65,000. The second deposits KSh 650,000. Leverage does not look at the deposit size when it sets the maximum position. It sets a ratio, so the larger deposit can hold a position ten times bigger before margin runs out. The ratio is the same. The room to move is not.

Take one standard lot at 1.0850. The notional value is $108,500. At 1:100, the margin is $1,085. At KSh 130 per dollar that is about KSh 141,050. The first deposit cannot open that position at all, because the margin needed is more than the money in the account. The second deposit can open it, and after the margin is locked it still has about KSh 508,950 of free margin left.

Now compare the same two deposits on 0.10 lots. The notional value is $10,850, and the margin at 1:100 is about KSh 14,105. Both deposits can open it. The first has about KSh 50,895 free after the margin is locked. The second has about KSh 635,895 free. The position is identical. The buffer against a losing move is not. Leverage gave both the same maximum. The deposit decided how much of that maximum was safe to use.

Free margin is the deposit minus the margin already locked. It is the money that absorbs a loss while the trade is open. If a trade moves against you, the loss comes out of free margin first. When free margin reaches zero, the broker can issue a margin call or close the position. The margin itself is not a fee and it is not lost. It is held, and it returns to free margin when the trade closes.

Use the pip value to judge the buffer. On one standard lot, one pip is about KSh 1,300. If you lock KSh 141,050 of margin from a KSh 650,000 deposit, free margin is about KSh 508,950. Divide that by KSh 1,300 and you get roughly 391 pips of room before free margin is used up. On 0.10 lots the pip value is about KSh 130, and the same deposit leaves far more room than that. The number of pips, not the leverage, is what tells you whether the trade can survive a normal move.

The common mistake is to read 1:100 as permission to use the whole deposit. It is a ceiling, not a target. A position that locks most of your deposit leaves a buffer of a few pips, and a small move against the trade can close it. A position that locks a small part of your deposit leaves a buffer of hundreds of pips. Both use the same leverage. Only one gives the trade room to breathe. The broker may round the margin figure, add a small buffer, or charge a spread or commission on top, so the real free margin can be slightly lower than the calculation.

Leverage changes the margin, not the pip value. On one standard lot of EUR/USD at 1.0850, the notional is $108,500 whatever the leverage setting. At 1:100 the margin is about KSh 141,050. At 1:200 it is about KSh 70,525. At 1:500 it is about KSh 28,210. The position size and the pip value stay the same. Only the amount locked against the position falls.

Lower margin looks like more free margin, and it is. The danger is that it also allows a larger position for the same deposit. If you use 1:500 to open five standard lots instead of one, the pip value rises to about KSh 6,500. A ten pip move against the trade then costs about KSh 65,000, which is the whole deposit. The leverage did not cause the loss. The position size did. Higher leverage simply removed the barrier that would have stopped the position from being opened.

The shilling conversion rate used here is an example and it varies. The broker's margin requirements also vary. Some brokers set different leverage limits for different account types, and the CMA regulates how these products are offered in Kenya. None of that changes the arithmetic. Work out the margin first, then check that free margin is several times larger than the margin you are locking. If the numbers do not fit, reduce the position size rather than raising leverage.