Margin to Equity Ratio

adast027's picture
Rank: Baboon | 132

Hi - I'm just trying to understand margin to equity ratio and please bear with me, but if anyone can help it would be appreciate.

I understand how it's calculated - nominal trading level / margin, so if an account is $1m and 250k is required then this M/E ratio is 25%.

However, what I'm trying to understand is how the lower the ratio it's considered less risky. I can understand that it makes a trader more efficient if they're using less cash if their margin to equity ratio is say 5% but doesn't this mean that they're just more levered up?

If the margin to equity ration is 5% doesn't this mean they're using 20x leverage and if it's 50% then they're using 2x leverage?

The more leverage up you are shouldn't this be riskier?

I'm assuming that what I'm mistaking here is that margin and leverage are not the same thing?

Sorry if this question seems very basic.

Comments (2)

Apr 17, 2013

Margin to equity ratio = margin amt / your notional investment, so for your example 250k/1000k = 25%.

More margin posted = more leverage, usually meaning more risk.

Think of it like this, you invest 1mm with w a cta, he buys 10 contracts of oil which require 100k of margin. Margin of equity would be 100k/1mm = 10%.

If instead cta takes more risk and buys 20 contracts, that requires 200k and so the ratio would be 20%, more risk.

Apr 17, 2013