Understanding the Basic Concepts of Trading

Trading Fundamentals | Beginner Course

Before learning how to analyse charts, identify market trends, or use technical indicators, it is important to understand how a trading account works. Terms such as leverage, margin, equity, spread, commission, and swap appear frequently on trading platforms. Understanding these concepts provides a foundation for later lessons in technical analysis and risk management.

In this lesson: Leverage • Margin & Free Margin • Balance & Equity • Spread • Commission • Swap Share

Trading fundamentals at a glance

1. What Is Leverage?

Leverage allows traders to control a larger market position using a smaller amount of their own capital. Instead of providing the full value of a position, a trader is required to provide only a portion of it as margin.

For example, with 1:100 leverage, the margin required is approximately 1% of the position value. Higher leverage therefore reduces the amount of margin required for the same position size.

Higher Leverage = Lower Margin Required for the Same Position Size

Leverage can magnify both gains and losses. It should therefore be considered together with position sizing and risk management.

2. What Is Margin?

Margin is the amount of money required to open and maintain a leveraged trading position. When a position is opened, the required margin is allocated from the trading account. Once the position is closed, that margin is released and becomes available again.

Margin = (Asset Price × Contract Size × Lot Size) ÷ Leverage

Example

Suppose a trader opens a 5-lot EUR/USD position at 1.35000. The contract size is 100,000 and leverage is 1:200.

(1.35000 × 100,000 × 5) ÷ 200 = $3,375

Under these assumptions, approximately $3,375 of margin would be required.

3. What Is Free Margin?

Free margin is the portion of account equity that is not currently being used as margin for open positions. It indicates how much capacity remains in the account to support additional positions or absorb changes in existing positions.

Free Margin = Equity − Used Margin

Example: if equity is $10,000 and used margin is $2,000, free margin is $8,000. Margin call and stop-out thresholds vary between brokers and account types, so traders should check the applicable trading conditions.

4. Balance vs Equity

Balance

Balance reflects realised profit or loss from closed positions. Unrealised profit or loss from positions that remain open does not normally change the account balance.

Example: an account has a $50,000 balance and an open position showing a $5,000 unrealised profit. The balance remains $50,000 until the position is closed. If the $5,000 profit is realised, the balance becomes $55,000.

Equity

Equity represents the current value of the account after including unrealised profits or losses from open positions.

Equity = Balance + Unrealised Profit/Loss

If the balance is $50,000 and open positions have an unrealised loss of $10,000, equity is $40,000. When there are no open positions, balance and equity will generally be the same.

5. What Is a Spread?

A currency pair is normally quoted using two prices: the bid and the ask. The bid is the price at which the base currency can be sold, while the ask is the price at which it can be bought. The difference between these prices is the spread.

Spread = Ask Price − Bid Price

Example: EUR/USD Bid 1.1000 and Ask 1.1002 gives a difference of 0.0002, or 2 pips.

Fixed and Variable Spreads

A fixed spread is designed to remain at a predetermined level under the broker’s pricing structure. A variable or floating spread changes with market conditions and may widen during periods of volatility or reduced liquidity.

6. What Is Commission?

Commission is a fee that may be charged by a broker or financial intermediary for executing a trade. It can vary according to position size, instrument, account type, trading volume, and pricing structure.

Commission may be quoted on a half-turn basis (one side of the transaction) or a round-turn basis (the combined opening and closing cost).

Fixed Commission

Example: $5 per lot per side would equal $10 per lot round turn.

Tiered Commission

Some pricing structures reduce the commission rate as trading volume increases. These structures are commonly associated with higher-volume or institutional trading arrangements.

7. What Is Swap?

Swap is an overnight financing adjustment that may be credited to or charged from a trading account when certain positions remain open overnight. In foreign exchange trading, it is related to factors including the interest-rate characteristics of the two currencies and the broker’s pricing methodology.

A positive swap results in a credit, while a negative swap results in a charge. Swap rates vary between brokers and can change over time, so current contract specifications should be checked on the relevant platform.

8. How These Concepts Work Together

Imagine depositing $10,000 into a trading account and using leverage to open a position. A portion of the account is allocated as margin, while the remaining available equity is free margin.

Unrealised profit or loss changes equity while the position is open, whereas balance generally changes when the result is realised. Entering and exiting a position may involve spread and commission, and holding it overnight may result in a swap or financing adjustment.

Key Takeaways

Leverage: Allows greater market exposure with a smaller amount of capital, but it also magnifies risk.

Margin: Is the amount of capital allocated to maintain a leveraged position.

Free Margin: Is the remaining equity not currently being used as margin.

Balance: Reflects realised results from closed positions.

Equity: Also includes unrealised profit or loss from open positions.

Spread: Is the difference between the bid and ask prices.

Commission: Is a transaction fee that may be charged when trades are executed.

Swap: Is an overnight financing adjustment that may apply to positions held overnight.

Educational Notice: This material is provided for educational purposes only and explains general trading concepts. It does not constitute investment advice, a trading recommendation, or an offer or solicitation to buy or sell any financial instrument. Leveraged financial products involve risk, and trading conditions vary between providers.