What is Forex Leverage in Rwanda?

An introduction to Leverage and Margin

Leverage 

Trading leverage refers to the ability to trade with more capital than what is available in one’s own account. It is a service provided by several exchanges to assist traders. Leverage can be thought of as a secured loan from an exchange or a peer. 

In this context, the collateral required is only a small portion of the loan amount, known as margin. For example, with 10X leverage, you would only need to provide 1/10th of the position value as collateral instead of the full amount. 

Leverage allows traders to deposit only a portion of their account balance and still trade as if they had invested the entire amount. It provides the opportunity to increase potential returns without risking the entire account balance. 

However, it is important to exercise caution and manage risk when using leverage. Many traders, particularly beginners, may misuse leverage by increasing their position sizes without considering the additional risk involved. This practice can be highly dangerous, regardless of the amount of leverage used. If the market moves against the trader’s position, it can quickly deplete the trading account, especially when trading with high leverage. 

In certain situations, if the market moves unfavorably and the loss incurred by the trader equals the margin amount, the exchange may automatically close the trader’s position and keep the margin. This is particularly applicable to exchanges that provide “fixed leverage,” where the margin requirement is established at the time of the transaction. If the position goes underwater by more than the margin amount, the exchange will liquidate the trade to prevent further losses. 

Another approach is cross leverage, which is commonly available with most forex brokers. It allows traders to consistently trade with the highest possible leverage. However, in this case, the exchange may lock up more of the trader’s balance as margin to ensure that potential profits can be paid out if the position moves against them. 

Margin 

The margin refers to the initial amount of money a trader needs to pay to enter a position. In margin trading, traders only need to provide a fraction of the position’s total value to open a trade. 

Leveraged forex trading involves understanding margin, which is distinct from transaction fees. Margin trading allows traders to increase their position size with a smaller initial capital investment. It is important to fully comprehend how leverage functions as it can amplify both profits and losses. 

The amount of leverage a trader can utilize is often limited by regulatory agencies such as ESMA. Margin requirements for popular currency pairs typically start around 3.33% in the United Kingdom, although specific requirements may vary depending on the forex broker, regulatory framework, licenses held by the broker, and the trader’s country of residence. 

Cash Account vs Margin Account 

Rwandan traders can engage in buying and selling securities through brokerage accounts. The two most common types of brokerage accounts are cash accounts and margin accounts. 

The primary difference between these two account types lies in the financial requirements. 

In a cash account, traders are only able to execute trades using the funds available in their account. They cannot use additional funds or borrow money from the broker to make trades. Before initiating any transactions, it is crucial for traders to ensure that they have an adequate amount of cash in their account. 

On the other hand, in a margin account, traders have the option to borrow funds from the broker to supplement their own capital. This allows them to trade with greater buying power than what is available in their account. Margin accounts require traders to maintain a specific level of equity, known as the margin requirement, which is a percentage of the total value of the securities held in the account.