Trading Forex on Margin and What Is Margin?

The reason for Forex trading popularity is margin. Without margin the Forex world would be beyond the reach of the common investor. So what exactly is margin and how does it work?

Margin trading allows Forex traders to control a large amount of currency using little of their own while borrowing the rest.

To obtain a margin account with a Forex broker will enable you to borrow money from the broker to trade currency lots with; the lots are worth $100,000.

The amount of borrowing power your margin account gives you is called "leverage". Leverage is usually expressed as a ratio- a leverage of 100:1 means you can control resources worth 100 times your deposit.

What this means in Forex trading terms is that with 1% margin in account you can control one standard lot/1 contract worth $100,000 with a $1,000 deposit.

However, Trading on margin increases both potential for profits as well as losses. In Forex you can never lose more than you invest losses are limited to your deposits and usually brokers will close a transaction that extends beyond your margin deposit by executing a margin call.

Benefits of Forex Trading

As mentioned above, trading on margin gives you more buying power and the potential for more profits or losses. How this works is; a 1% margin trading account allows you to control a position size of $100,000 with $1,000. When you are trading with $100,000 small market changes in the price of the currency can result in large profits or losses.

Forex currencies movements in Forex are measured using point known as pips. For example, the US dollar, is traded in units down to 4 decimal places, the last decimal place used to quote currencies is called a pip. Instead of $1.5 Forex quotes like in the Forex bureaus, the price is quoted as $1.5012. When you are trading $100,000 then each pip is worth $10 profit. So if this price moves up 1 pip to $1.5013 you will make $10 profit.

If price changes from 1.5012 to 1.5062 is a difference of 50 pips which represents a profit of $500. Without margin trading if you had $1000 of capital, the price change from 1.5012 to 1.5062 represents a difference of $0.5 profit. So the benefit of margin trading is increased profit potential.

Risks of Forex Trading

As there is increased potential for profit so is the potential for loss. If you are not cautious your entire margin account of $1000 could quickly be wiped out. If your margin account is 1% and a currency moves just one cent (100 pips) against you and you lose $1000.

However, Forex trading has several methods to limit loss such as Stop loss orders that automatically close your position at a specified point. Stop loss orders allow you to limit your losses to a specified amount while still allowing potential for profit.

Another risk is the risk of getting a margin call if your positions moves against you and accumulates a big loss.

To trade profitably with leverage and margin you must know about Forex money management and Forex stop loss.

View the original article here