Commodities Leverage & Margin Trading Explanation & Example

Margin required : It is the amount of money your commodity broker requires from you to open a position. It is expressed in percents.

Equity : It is the total amount of capital you've in your account.

Used margin : amount of money in your trading account which has already been used up when buying a commodity contract, this contract is the one that is displayed in open trade positions. As a trader you can't use this amount of money after opening a trade order because you have already used it and it is not available to you.

In other words, because your commodity broker has opened up a position for you using the capital you've borrowed, you must maintain this usable margin for your account as a security to allow you to continue using this commodity leverage he has given you.

Free margin : amount in your trading account which you can use to open new trade positions. This is the amount of money in your account which has not yet been commodity leveraged because you have not yet opened a transaction with this money - this money also is very important for you as a investor because it enables you to continue holding your open trades as will be explained below.

However, if you over use commodity leverage, this free margin will drop below a certain percent at which your commodity broker will have to close all your positions automatically, leaving you with a big loss. Commodity broker at this point will automatically close-out all your open trade transactions because if your open trades are left open then your broker would lose money that you would have borrowed from them.

This is why you should always make sure you've a lot of free margin. To do this never trade more than 5 percentage of your commodities trading account, in fact 2 percentage is recommended.

Difference Between Commodity Leverage Set by Broker & Used Commodities Trading Leverage

If the set commodity leverage is 100: 1, what it means is that you can borrow up to 100 dollars for every dollar you have in your account, but you do not have to borrow all the 100 dollars for every dollar you have you can decide you want to borrow 50:1 or 20:1. In this case though the leverage option is set at 100:1 your used commodities leverage will be the 50:1 or 20:1 that you have borrowed to make a trade.

Example:

You have 1000 dollars (Equity)

Set 100:1

Commodity Trading Leverage Used = Amount used /Equity

If you buy commodity lots equal to 100,000 dollars you will have used

= 100,000/1000

= 100:1

If you buy commodities trading lots equal to 50,000 dollars that as a trader you will have used

= 50,000/1000

= 50:1

If you buy commodities trading lots equal to 20,000 dollars that as a trader you will have used

= 20,000/1000

= 20:1

In these 3 cases you can see that even though the set is 100:1

The used is 100:1, 50:1, 20:1 depending on the size of commodity lots traded.

So Why not Just Select 10:1 option as the Maximum Commodity Leverage? Because to keep within proper risk management rules it's even recommended that traders use less than this?

This question may seem straight forward but it is not, because when you trade you use borrowed money known A.K.A. Commodity Trading Leverage. When you borrow capital from anyone or a bank you must maintain a security or collateral to acquire a loan, even if the security is based on monthly deduction from your salary, the same thing with Commodities.

In commodity the security is known as margin. This is the capital you deposit with your broker.

This is calculated in realtime as you trade. To keep your borrowed money you must maintain what is known as the required capital (your deposit).

Now if Your Commodity Trading Leverage is 100:1

When trading if you have $1,000 & use option 100:1 and buy 1 standard lot for $100,000 your margin on this transaction is $1000 dollars in your account, this is the money that you will lose if your open trade goes against you the other $99,000 that is borrowed, they will close the open commodity trades automatically once your $1,000 has been taken by the commodities market.

But this is if your commodity broker has set 0% Commodities Trading Margin Requirement before closing your commodities trades automatically.

For 20% requirement before closing your commodities trades automatically, then your trades will be closed once your balance gets to $200

For 50% requirement of this level before closing your commodities trades automatically, then your trades will be closed once your balance gets to $500

If they set 100% requirement of this level before closing out your open trade positions automatically, then your trade will be closed once your balance gets to $1,000: Meaning the trade will close-out as soon as you execute it because even if you as a trader you pay 1 pip spread your trade account balance will get to $990 and the needed percentage is 100% i.e. 1,000 dollars, therefore your orders will immediately get closed.

Most brokers do not set 100% requirement, but there are those who set 100% are not suitable for you at all, choose those set 50% or 20% margin requirements, in fact, those commodities brokers which set their margin requirement at 20% are some of the best because the likely hood they closeout your trade is reduced as displayed in example above.

To know about this level which is calculated by your platform automatically - The MetaTrader 4 Commodities Trading Platform will display this as "Commodities Trading Margin Requirement", This will be displayed as a percent the higher the percentage the less likely your trades are to get closed.

For Example if

Using 100:1

If commodity leverage is 100:1 and you transact commodity lots equal to $10,000

$10,000 dollars divide by 100:1, used capital is $100

Calculation:

= Capital Used * Percentage(100)

= $1,000/$100 * Percentage(100)

Commodities Margin Requirement = 1,000 %

Investor has 980% above required amount

Using 10:1

If commodity leverage is 10:1 and you transact commodity lots equal to $10,000

$10,000 dollars divide by 10:1, used capital is $1000

Calculation:

= Capital Used * Percentage(100)

= $1,000/$1000 * Percentage(100)

Commodities Trading Margin Requirement = 100%

Investor has 80% above the required amount

Because when a trader has a higher commodity leverage means that they have more percent above what is required(A.K.A. More "Free Commodities Trading Margin") their open commodity transactions are less likely to get closed. This is reason why traders will choose the option 100:1 for their trading account but according to their risk management rules, they will not trade above 5:1.

These Areas are Shown on The Software Image Below as an Examples:

MetaTrader 4 Commodities Trading Software