A leveraged margin position is a spot trade executed through an advance financed by Kraken. For example, a long XBT/EUR position is opened by advancing the trader EUR to buy XBT in a spot trade. And a short XBT/EUR position is opened by advancing the trader XBT to sell for EUR in a spot trade. Since funds are advanced to open a position, the profit or loss is unrealized until the position is closed.
To create a margin order, you enter everything in the order form just as you would for a regular spot trade (the "Amount" field still determines the size of the order, the price parameters for the various order types work the same, etc.) - EXCEPT you select a level of leverage for the order. Selecting a level of leverage means that the order, if executed, will execute a spot trade through an advance financed by Kraken (rather than a spot trade executed directly from the balances in your account if no leverage is selected). You can select leverage in the intermediate and advanced order forms.
What about the different levels of leverage? The different levels of leverage just determine how much of your account balance is "tied" to the position as a kind of "collateral" for the advance used to open the position. For example, if you have 10 XBT in your account and open a 5 XBT long @5:1 leverage, then 1 XBT is tied to the position. Since only 1 XBT is tied to the position, you could withdraw up to 9 XBT, but not more, because that last 1 XBT is tied to the position. Similarly, the 9 XBT is available in your account as buying power for opening more positions or making other trades. With 5:1 leverage, you could open positions up to 50 XBT in total volume (but keep in mind that while having positions that are much larger than the balance of your account gives you the chance of larger profits, it also puts you at greater risk of larger losses, margin call, or even liquidation, so be very careful about doing this).
Alternatively, if you select 2:1 leverage instead of 5:1 leverage, then 2.5 XBT would be tied to the 5 XBT position. In this case you would only be able to withdraw up to 7.5 XBT and would only have 7.5 XBT buying power left for other trades.
The possibility of larger profits along with the risk of larger losses or margin call and even liquidation is really determined by the size of the position relative to your account balance (and not merely by the level of leverage you select). If you have a 10 XBT balance and open a 5 XBT position, the choice of 5:1 leverage over 2:1 leverage does not really make the position more risky. In many cases it may be better to just choose the higher level of leverage leaving more buying power in the account, so long as the trader is mindful of not getting to the point where the size of the position relative to the size of the account goes beyond their risk tolerance.
Another key point to keep in mind is that not all currencies are margin currencies - i.e. currencies that can be "collateralized" for the advance. Currently the only margin currencies on Kraken are XBT, EUR, and USD. So, for example, if you only have ripples (XRP) in your account, you will not be able to margin trade at all.