Forex Margin Trading: Make More Money With Less
Forex margin trading is a way of applying leverage to increase the purchasing power
of your money. Leverage simply means using a small sum to control a much larger
sum. This is possible because it is unlikely that the value of a currency will change
by more than a certain percentage over a short time. So you can place a few hundred
dollars in your brokerage account to trade on the margin - the amount that you think
the price will fall. Your broker will in effect lend you the balance.
Trading on margins is also known in stock and futures trading, but because of the
special nature of currencies, you can get a lot more leverage in the forex market.
Depending on your broker's terms, you may be able to control 50, 100 or even 200
times your account balance.
This can lead to big profits if you are successful, but it can also mean big losses
if not. In general, the more leverage you use, the more risky your trading is.
We can understand leverage and margins if we consider an example.
Imagine that the current rate on the British pound to US dollar forex market is
shown as GBP/USD 1.7100. So to buy one British pound you would need $1.71. If you
expected the value of the dollar to rise against the pound you might decide to sell
enough pounds to buy $100,000. If your broker used lots of $10,000 each, this would
be 10 lots. Then you would sit back and wait for the price to go up.
A few days later you might find that the price had moved to GBP/USD 1.6600. Sure
enough, the dollar has risen and the pound is now worth only $1.66. If you sell
your dollars now and buy back into pounds, you will have made a profit of 2.9% less
the spread. 2.9% of $100,000 is $2,900, so that would be an excellent trade.
But most of us do not have $100,000 spare cash that we want to trade on the currency
exchange market. So here is where the principle of forex margins comes into play.
Since you are buying and selling different currencies at the same time, your own
money only has to cover any loss that you might make if the dollar falls instead
of rising. And you would put a stop loss into place to limit that loss, so $1,000
might be all you needed to have in your account to make this $100,000 purchase.
Your broker guarantees the other $99,000.
In fact many brokers now operate limited risk amounts where the account will automatically
close out the trade if whatever funds you have in your account are lost. This prevents
margin calls which can be disastrous for a trader because they mean that you can
lose more than you have. But with a forex limited risk account that is not a possibility.
The broker's software that you use to control your account will not let you lose
more than your account balance.
Using leverage in this way is so common in currency trading that you will soon do
it without even thinking about it. Still it is important to keep in mind the risks.
Lower leverage is always safer and you may never want to go to the maximum forex
margin that your broker would allow.
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