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Understanding
How To Use Margins and Leverages In Forex Trading
One of the
biggest advantages that forex trading offers, is the ability
to trade on margin. Through margin trading, you can buy large
amounts of foreign currency with only a small part of its full
value.
People involved
in forex trading often use the terms “trading on margin”
and “leverage trading”. These two terms actually mean
similar things, and are simply phrased in different ways.
Leverages
quotes typically make use of a ratio; say for example, 100:1.
Simply put,
this means you purchase 100 units of currency using only 1 unit.
This means that in a trade with a value of $100,000, you only
put up $1000.
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Margin trading
is much the same as leverage trading, merely from another point
of view. Instead of using ratios, margin quotes use percentages.
For example, 10% indicates that you can trade $10,000 worth
of currency while only having to put up $1000.
Many
forex traders trade using margin in order to increase the size
of their profits. Traders must trade large amounts of currency
in order to make profits due to the relatively low value of
a single pip.
Leveraged
trades allow smaller investors with
less capital than large investors to realize large profits as
well. Margin is a double-edged sword, however, and you must
use it with care else you may find yourself broke in a very
short span of time.
If you open
a new account with a forex broker, they will require that you
deposit a minimum amount of money into your account before you
are allowed to start trading. The value of this minimum amount
differs from broker to broker, and has no general set value.
For each
trade that you make, part of the value in your account will
be earmarked for use as the initial margin requirement for your
trade. The following is an example of this.
You deposit
$10,000 into a new account, then conduct a trade at leverage
of 100:1. If, for example, you purchase $100,000 of currency,
you need to put up $1,000. You now have $9,000 left in your
margin account, after having used that $1,000.
You must
pay close attention to the amount of money left in your margin
account. If you lose money on the currency that you have
bought, the remaining $9,000 of margin funds in your account
will be used to cover your losses. If the remaining money in
your account is used up, however, your broker will simply liquidate
your positions, leaving you to deal with the losses. This prevents
you from experiencing further losses if prices move further
against you.
Everyone
wants to avoid receiving margin calls, and you can do so by
making use of stop-loss orders. This allows you to take
yourself out of the running before you reach the point of liquidation.
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