Margin and Leverage in Forex

Margin and Leverage are very important concepts to understand in Forex trading. Both refer to a similar concept from a slightly different angle. When a trader opens a position, they are required to deposit a fraction of the open position with the broker. This is known as the “Margin Requirement”.  This is often also referred to as a “good faith deposit.” This is because the trader will receive the amount back when they close the position out.

Margin

When you open your Forex account, the broker will request that you deposit a small sum into the account. This is, known as the 'margin'. Think of this as insurance for the broker against any losses that you may incur on your account. With this deposit you are able to control a proportionally much larger amount of currency i the market. This enables you to achieve both greater gains and equally greater losses than you would be able to achieve with your deposit alone.
This margin deposit is used in conjunction with leverage to allow the trader to control a proportionally much larger amount of currency than could be achieved by the deposit alone. This enables both greater gains and equally greater losses to be achieved.
Most trading platforms will generally display both the current margin in use for open positions and the amount of margin remaining available to open new positions.
You level of margin will fluctuate with underlying price of the market and therefore should be watched closely. When an account runs out of tradable margin the trader will receive the dreaded ‘margin call.’ Essentially this means that there is insufficient equity in the account to meet the minimum margin requirement for open positions in the account.
When this happens the Forex Broker will immediately liquidate all open positions at current market rates.
Whilst most brokers will guarantee that you cannot lose more than you have deposited in your account this is only of some consolation, as a margin call effectively means that you have blown your account!

Leverage

Leverage is the amount that a trader can control via their deposited margin. This is determined by a leverage ratio set when the trade is executed. The leverage ratio is fairly straight forward to understand. It simply multiplies the trader’s potential gains and losses in the market by the ratio set.
For example: Lets assume a deposit of $1,000. A leverage ratio of 100:1 would allow you to trade $100,000, a leverage ratio of 200:1 would allow you to trade $200,000 and so on. On the other hand, If you were to only trade $ 10,000, then the actual leverage that you would be using would be 10:1.
Leverage is often viewed as a double edged sword. While it can substantially increase gains when positions move in your favor, it can similarly magnify losses if an open position moves against you.
The exact amount to leverage trades is down to the individual trader. The trading strategy employed may have some influence on this. Shorter term traders for example may feel more comfortable with more highly leveraged positions given the shorter period of time they are exposed to the market. The important lesson to learn here is not to over leverage your account. This also applies to having too many simultaneous positions opened. Leverage should only be used with an understanding of the implications. Just because your broker will give you access to a great deal of leverage in your account it doesn't’t mean you should always use it.
It’s very important to gain a good grasp of these two concepts before engaging in any deals, because leverage and margin determine the life span of any trading account in a far more decisive manner than the Forex strategy employed.

From: http://www.forextechnicalchartist.com