Examples

Here are some examples to help tie all this together. Suppose you fund an account with $5,000 and open a $10,000 short position in XBT/USD using 5:1 leverage. Your margin is one-fifth of the amount borrowed for the position, or $2,000. The margin level when you open the position is ($5,000 ÷ $2,000)×100 = 250%. If your position has an unrealized loss of $3,500, your equity would be $5,000 - $3,500 = $1,500. Your margin level would then be ($1,500 ÷ $2,000)×100 = 75%. At this level, you are in danger of getting liquidated. As you can see from this example, it's possible to open a position twice as large as your account balance and still be able to endure a sizable loss before margin call. Your own risk management on this trade should have you closing your position well before margin call, but it's good to understand what the limits are.

Let's see what happens in the example above if 2:1 leverage is used instead of 5:1. With 2:1 leverage the margin for the position is $5,000. So as soon as the position is opened the margin level is 100%. The system might let you open this position (though it wouldn't let you open a position where your margin level starts below 100%), but it wouldn't be a good idea to open a position where your margin level starts so low because you are already close to being liquidated. An unrealized loss on the position of $1,250 would bring your margin level to 75% where you are in danger of being liquidated (check this yourself). More leverage should be used so the margin level starts higher, and a stop should be set on the position so that the position is closed well before there is any danger of margin call.

You need to be careful about opening a very large position relative to the size of your account. Suppose in our example that you open a $20,000 position instead of $10,000 (again with 5:1 leverage). Your margin for this position is $4,000. Your starting margin level is ($5,000 ÷ $4,000)×100 = 125%. If this position has an unrealized loss of 10% ($2,000), this would put you at margin call (margin level of 75% - check this yourself). To avoid this, suppose you set a stop on the position of 5% ($1,000). If this stop is reached, your account will lose 20%. Since the position is four times as large as your trade balance, your account balance will gain or lose four times as much (percentage-wise) as the position.

Leverage isn't so dangerous in itself. The danger comes when you use leverage to open a very large position relative to your account size - this is one way traders wipe out their accounts.