Leverage

An arrangement, not an instrument and not a service. In a leveraged position the result is computed on the whole value of the contract, while the money held behind it is a percentage of that value. An adverse move is therefore measured against the whole contract: it can exhaust the margin posted entirely, and it is not limited to the amount deposited. A favourable move is measured on exactly the same basis and to exactly the same degree. Gearing is the older British word for the identical arrangement, and gearing ratio is the entry that covers that usage.

The percentage in question is the margin requirement, the proportion of the full contract value that has to be posted and held for as long as the contract is open. It is set per instrument by the counterparty and, in regulated markets, sits above a floor the regulator imposes, which is why the same instrument can carry different requirements at firms licensed in different places. Rulebooks and supervisors state it as a percent of contract value rather than as a comparison between the two figures, because a percent reads as a constraint on the size of a contract, which is what it is.

Margin is collateral, not a payment and not a cost line. It is held while the contract is open and released when it closes, it is drawn from the same equity every other position is measured against, and the part of equity not held against anything is the free margin standing between the account and a close out. That is why a leveraged position can be closed by the firm on a margin close-out long before any view about the market has been resolved.

The most common error is reading the margin requirement as a cap on the loss. It is the amount posted in order to open and hold the contract, and the loss is computed on the contract, so the two figures are not the same kind of thing and the second is not bounded by the first. The second error is treating leverage as a property of a market. It changes nothing about the direction of a price, the likelihood of any outcome, or the cost of dealing: it changes the size of the contract relative to the money held behind it, and both results move with it in the same proportion.