DADA
Spreads, Leverage and Margin
Trading involves more than choosing whether a market may rise or fall. Traders also need to understand trading costs, leverage and margin because these factors can directly affect both potential gains and potential losses.
What Is a Spread?
In many markets, there are two prices displayed for an asset: the bid price and the ask price.
The difference between these two prices is called the spread.
Example selling price
Example buying price
The spread can represent part of the cost of entering and exiting a trade.
Why Do Spreads Change?
Spreads are not always fixed. Depending on the market and platform, they may become wider or narrower.
Liquidity
Highly active markets may sometimes have tighter spreads.
Volatility
Rapid market movement can sometimes cause spreads to widen.
Trading Hours
Market activity can change depending on the time of day.
Major Events
Economic announcements or unexpected events can affect pricing.
What Is Leverage?
Leverage allows a trader to control a larger market position using a smaller amount of their own capital.
Leverage is commonly expressed as a ratio, such as 2:1, 5:1 or 10:1.
Why Leverage Requires Caution
Beginners can mistakenly focus on the larger potential returns created by leverage while overlooking the increased risk.
Smaller Exposure
Market movements generally have a smaller effect on the account when position exposure is lower.
Larger Exposure
The same market movement can have a much larger financial effect when exposure is increased.
Leverage does not make a trade more likely to succeed. It changes the amount of market exposure and therefore the potential financial impact.
What Is Margin?
Margin is the amount of capital that a broker or trading platform requires to open and maintain a leveraged position.
It is important to understand that margin requirements can vary between platforms, instruments and market conditions.
$10,000 Position
10:1 leverage
What Is a Margin Call?
If losses reduce the available funds in a leveraged trading account, the account may no longer meet the platform’s required margin level.
Depending on the platform, this can result in a margin warning, additional funding requirements or positions being automatically closed.
Leverage and Position Size
Having access to leverage does not mean a trader must use the maximum amount available.
Position size should be based on a trading plan and acceptable risk, rather than simply on how much exposure the platform allows.
The question should not only be “How large a position can I open?” but also “How much am I prepared to lose if the trade moves against me?”
Understand Trading Costs
The spread may not be the only cost associated with trading. Depending on the platform and instrument, other charges may apply.
- Spreads
- Trading commissions
- Overnight or financing charges
- Currency conversion costs
- Other platform-specific fees
Traders should understand the complete fee structure of the platform they use before placing trades.
Leverage Can Magnify Losses
Leverage is one of the most important risks for a beginner to understand. A relatively small market movement can have a significant impact on a highly leveraged position.
Key Takeaways
- The spread is the difference between bid and ask prices.
- Spreads can change with liquidity and market conditions.
- Leverage allows greater market exposure with less capital.
- Leverage magnifies potential losses as well as potential gains.
- Margin is capital required to support a leveraged position.
- Margin requirements vary between platforms and instruments.
- Trading costs should always be understood before entering a position.
- Available leverage should never determine acceptable risk.
DADA Trading Academy materials are provided for general educational purposes only and do not constitute personalized financial, investment or trading advice. Trading involves risk and losses are possible.