Foreign Exchange Margin Trading: Make More Profits With Less Using Your Broker's Capital
Forex margin trading is a method of using leverage to enhance the purchasing power of your trading funds. 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 fluctuate by more than some percentage points within a short time. So you may place a few hundred dollars in your brokerage account to trade on the margin - the amount that you think the price may change. Your broker will in effect lend you the balance.
Trading on margins is also known in equities and commodities trading, but due to the special nature of currencies, you may get a lot more leverage in the foreign exchange markets. Depending on your broker's terms, you may be able to control 50, 100 or even 200 times your account balance.
This could produce large returns if you are successful, but it can also mean big losses if not. All in all, the more leverage you use, the more risky your trading is.
We can understand leverage and margins if we consider an example.
Assume that the current rate on the British pound to US dollar currency market is shown as GBP/USD 1.7100. So to purchase one British pound you would need $1.71. If you forecasted the value of the dollar to go up against the pound you can 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 earned a profit of 2.9% less the spread. 2.9% of $100,000 is $2,900, so that would be an outstanding trade.
But most individuals do not have $100,000 spare cash that we can use to trade on the currency exchange markets. 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 simply has to cover any loss that you would possibly make if the dollar falls instead of rising. And you would use a stop loss to limit that loss, so $1,000 could 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 may lose more than you have. But with a forex limited risk account that is impossible. The broker's platform that you use to control your account will not let you lose more than your deposited funds.
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. You can also reduce your risk by using highly reliable forex signals. There are numerous forex signal providers available online. But keep in mind the fact, that not all forex signals are winners, so don't bet too much on any single position.
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