Offered leverage and effective leverage

Two accounts, one requirement 

A margin requirement states the percentage of a contract's value that has to be set aside while the contract is open. It is a condition on what can be opened, and it says nothing whatever about what is opened. An account with a given equity, facing a given requirement, has a ceiling: the largest contract value that equity could support if every last unit of it were committed. That ceiling is a description of a boundary, and a boundary is silent about everything inside it.

The quantity the boundary is silent about is the one that does the work. Exposure is the value of the contracts actually open, price multiplied by units, the same figure profit and loss is calculated on. Two positions in one instrument, under one requirement, opened in the same minute, can differ in that figure by any factor at all, because the units are written on the ticket and nothing in the requirement writes them. The word leverage gets used for both quantities, which is why it is worth splitting into two names before anything else in this lesson is said.

The maximum a requirement permits 

A requirement expressed as a percentage of contract value implies its own maximum. Equity divided by that percentage gives the largest contract value the equity could support, and trading literature calls the result offered leverage, permitted leverage or maximum leverage. The naming is unhelpful, because offered suggests something handed over. What the figure actually marks is a limit: the point past which a position cannot be opened at all, because the amount that would have to be set aside exceeds the amount available to set aside.

Two properties of that limit are worth being exact about. It obliges nothing. An account that commits a small fraction of what the ceiling allows has satisfied the requirement precisely as fully as one that commits all of it, and the requirement itself expresses no preference between them. And it is not a fixed property of an account, because it is arithmetic on two moving inputs: a requirement the counterparty publishes per instrument and revises, and an equity figure that changes with every tick on every open position.

The consequence is that a permitted maximum, on its own, is not a fact about risk. It bounds the set of positions that can be opened. It does not report which one was opened, and two accounts sitting under an identical ceiling can be carrying wholly different amounts of the market.

What the position actually creates 

The figure that describes a position rather than a boundary is the exposure carried divided by the equity behind it. Total contract value across everything open, over the account's equity. Practitioners call it effective leverage, and unlike the permitted maximum it is published nowhere and reported by no field on the account panel. It is worked out from two numbers the panel already shows.

The last two rows are the definition restated in the form that matters. Effective leverage is the factor by which a percentage move in the instrument's price is translated into a percentage move in the account's equity. A loss arrives multiplied by that factor, is not limited to the amount deposited, and can consume the margin set aside and carry on past it; a gain arrives multiplied by exactly the same factor, because it is the identical multiplication with the sign reversed. The factor is symmetrical and the account's capacity to absorb the two outcomes is not, since equity can reach a level at which positions stop being the account holder's to keep open, and there is no corresponding level in the other direction.

The figure is chosen by position size 

Because exposure is price multiplied by units, and price is not a choice, the effective figure moves proportionally with the units on the ticket. Halving the units halves it. Quartering them quarters it. Nothing in the published requirement participates in that arithmetic, so the requirement fixes the ceiling and the size fixes where beneath the ceiling a position sits.

That is the sense in which effective leverage is chosen rather than granted. It is settled at the moment a size is entered, whether or not it is thought about as a decision at all, and an account that has never calculated the figure still has one. It is also the reason this module treats position sizing and margin as one subject read from two ends.

The final three rows are the ones to keep. Three distances to the same outcome, produced by one instrument under one requirement from one starting equity, with the requirement doing none of the work. The distance is the inverse of the effective figure, which is the entire relationship between position size and how much room an account has.

It moves when nothing is traded 

The denominator of the effective figure is equity, and equity is the balance plus the running profit or loss on positions still open. It therefore moves continuously while the numerator, fixed by the units, moves only with the price. An unrealised loss lowers the denominator, and the effective figure rises. No ticket was written, no size was changed, and nothing on the platform was touched.

The direction of that drift is worth stating plainly, because it is the opposite of intuitive. A position that is losing carries a higher effective leverage than the one that was opened, so each further step against it removes a larger fraction of what remains than the step before it did. A position that is gaining carries a lower one, so each further step in its favour adds a smaller fraction. The mechanism accelerates into a loss and decelerates into a gain, and it does so without any instruction from anybody.

The same arithmetic explains two things that look unrelated to position sizing. A deposit raises equity, so it lowers the effective figure across every position already open. A withdrawal lowers equity, so it raises the figure across every position already open. Neither transaction touches an instrument, and both change how far the market has to travel.

Which of the two the close out rules read 

Neither figure is a field the close out rules consult. Those rules read margin level, which is equity divided by used margin, and used margin is the requirement applied to exposure. Both quantities in the effective figure therefore appear in margin level as well, arranged differently, and for a fixed requirement the two move in exact opposition: the higher the exposure carried per unit of equity, the lower the margin level the account starts from and the shorter the distance to any threshold.

That is the sense in which only one of the two numbers bites. A permitted maximum is identical for two accounts facing the same requirement and predicts nothing about either. The effective figure and the margin level are two readings of the same pair of quantities, and they describe both accounts exactly.

The two distances in that block are the argument of the whole lesson in one pair of figures. Same firm, same instrument, same published terms, same starting equity, and one account has several times as much room as the other because it wrote a smaller number on the ticket.

Where practitioners disagree 

Effective leverage has no standard definition, and the disagreements are about both halves of the fraction. On the denominator, one convention divides by equity and another divides by balance. Equity moves with every tick, so the figure it produces is live and reconciles directly with margin level. Balance is stable, so the figure it produces describes the decision as it was taken and is not disturbed by an open loss. The two diverge precisely when a position is losing, which is when the figure tends to be consulted, so a stated effective leverage is uninterpretable without knowing which denominator produced it.

On the numerator, the question is what to do with several open positions. Summing the contract values gross treats two positions that habitually move in opposite directions as though they added, which overstates the exposure carried in ordinary conditions. Netting them treats an offset as dependable, which understates it in the conditions where relationships between instruments stop holding. Neither convention is safe in both regimes, and positions denominated in different currencies add a conversion step that has its own moving price.

The last disagreement is about the permitted maximum itself. One tradition holds that it is close to irrelevant, since it obliges nothing and any size beneath it remains available. Another holds that a ceiling is never inert, because it sets the range of sizes reachable from a given equity and the extremes of a range are reached. Both are arguments about behaviour rather than about arithmetic, and neither has settled evidence behind it. What is not in dispute is the mechanical claim this lesson rests on: the ceiling does not appear in the calculation of what a position does to an account, and the size does.