Online Forex Trading
Online Forex Trading - Understanding Margin and Leverage
- Understanding Margin and Leverage
Being able to trade on margin is one of the greatest advantages of forex trading. You can purchase large quantities of currency while only putting up a small fraction of the full value.
You may hear some people refer to "leverage trading" and other to "trading on margin". In forex trading, they refer to the same thing, just in different terms.
Leverage is usually quoted as a ratio such as 100:1. This simply means that you can trade 100 units of currency while only putting up 1 unit. In other words you would only need to put up $1,000 in order to trade $100,000.
Margin is the same thing, just from a different point of view. Margin is generally quoted as a percentage such as 10%. In this example you would be able to trade $10,000 of currency while only putting $1,000 down.
Successful forex traders use margin to explode their profits. Since the value of a single pip is quite low, you have to trade large lots of currency to make a profit.
Huge Reward / High Risk
Being able to make leveraged trades enables small investors without a lot of capital to make big profits. However, margin cuts both ways and you must use it wisely or you'll find yourself broke in no time.
When you first open an account with a forex broker you will be required a minimum amount of funds into the account before you can trade. The minimum account value varies from one broker to the next.
When you make a trade, part of your account balance is earmarked as the initial margin requirement for that trade. Let's look at an example.
You open an account and deposit $10,000 into it. You then make a trade at 100:1 leverage. You buy $100,000 of currency, but are only required to put up $1,000. So you now have $1,000 in used margin and another $9,000 in available margin.
It's important to keep track of how much margin you have available. If prices move against you, some of the $9,000 you have as usable margin will be used to compensate for your losses. If your balance falls too low, the broker will liquidate your positions and you will be hit with a big loss. This does however prevent you from losing more than you could if they left your position open and prices continued to go against you.
No one wants to receive the dreaded margin call. But you can effectively eliminate it by using stop-loss orders to cut your losses before they near the point of liquidation.