Maximum Leverage
What Is Maximum Leverage?
Maximum leverage is the largest allowable size of a trading position permitted through a leveraged account. Leverage involves using borrowed funds to purchase securities or investments. In brokerage accounts, leverage can be obtained in the form of margin, a good faith deposit with the broker to buy or sell a larger position than the amount deposited.
Leverage can increase the magnitude of gains or losses on a trade, and so it can increase the volatility and the risk of a portfolio.
KEY TAKEAWAYS
- Maximum leverage is the largest position size permitted in a leveraged account based on a customer’s margin requirements with their broker.
- Stock investors are allowed to borrow up to 50% of the value of a position under Reg T, but some brokerage firms may impose more stringent requirements.
- Maximum leverage in the currency (forex) markets can be quite high; some firms allow leverage of more than 100:1.
- Futures margin requirements and maximum leverage will vary depending on the specific product being traded.
Understanding Maximum Leverage
Due to the risky nature of trading with borrowed funds, guidelines and regulations regarding a maximum allowable amount of leverage for stock trading were established under Regulation T, which establishes minimum quantities of collateral or margin that must be on hand for credit to be extended to clients. Brokerage firms might impose more stringent requirements to limit risk further.
Foreign exchange trading has much more relaxed standards. Leverage on currency trades can be anywhere from 50 to 400 times. Exceeding or even getting close to the maximum leverage point can be an untenable situation for forex traders, since a small price movement can quickly wipe out the entire amount of equity in the trading account. In the futures market, maximum leverage is based on futures margin requirements, which are good faith deposits and typically equal to 5% to 15% of the value of the futures contract.
Examples of Maximum Leverage
Brokerage firms are able to establish their own rules for how much leverage they allow to be placed when their clients trade and how much collateral must be on hand. However, the Federal Reserve Board established Regulation T which requires at least half of the purchase price of a stock position be on deposit. For example, an investor cannot borrow more than $1,000 to buy $2,000 worth of stocks within a brokerage account.
Currency trading has its own rules. Typical leverage available on currency pair trades through forex trading institutions ranges from 50 to 400 times. With a lever ratio of 50, for example, an individual with a margin deposit of $5,000 can initiate a maximum lever trading position of up to $250,000.
When trading futures, specific margin amounts are set by the futures exchange and are often determined by the volatility of the futures contract. For example, if a crude oil futures contract represents 1,000 barrels and, if crude is trading $55 per barrel, the size of the contract is $55,000 (1,000 x $55). If margin is $4,350, or roughly 8% of the contract size, that amount is the maximum leverage when trading one oil futures contract.