The (Foreign Exchange) Forex Trading Market Explained.
 

 

Trading Currencies on Margin

FOREX traders use margin account in a successful FOREX trading system

The key to FOREX popularity is margin.  Without margin, the FOREX would be beyond the reach of the average investor.  So, what exactly is margin and how does it work?

Margin accounts allow FOREX traders to control large amounts of currency with a relatively small deposit.  Establishing a margin account with a FOREX broker enables you to borrow money from the broker to control currency lots which are usually worth $100,000.  The amount of borrowing power your margin account gives you is the leverage.  Leverage is usually expressed as a ratio – a leverage of 100:1 means you can control assets worth 100 times your deposit.

What this means in FOREX is that with a 1% margin account you can control standard lots of $100,000 with a $1,000 deposit.  Trading on margin increases both profits and losses, and the potential exists for the trader to lose more than his original deposit.  With proper safeguards, however, loss can be limited, and usually brokers will terminate a transaction that extends beyond the margin deposit.

Benefits to FOREX traders of margins in your FOREX trading system

As we mentioned above, trading on margin gives you more buying power and the potential for more profits (and losses).  How does this work, exactly?  A 1% margin account allows you to control a currency lot of $100,000 for $1,000.  When dealing with $100,000 small changes in the price of the currency can result in large profits or losses. 

FOREX currencies are traded in much smaller units than cash.  The American dollar, for example, is traded in units down to 4 decimal places.  Instead of $1.32 FOREX quotes are seen as $1.3256.  The smallest unit in FOREX currencies is called the pip, and when you have a $100,000 each pip of your total lot is worth $10 (when trading American dollars).

If the price of American dollars changes from 1.3256 to 1.3356, that's a difference of 100 pips which represents a profit or loss of $1000.  Without margin, if you had $1000 of currency, the price change from 1.3256 to 1.3356 represents a difference of $10.  Significant to the tourist, perhaps, but not the investor.

So the benefit of margin is increased profit potential.

Risks

As there is increased profit potential, there is also increased loss potential.  If you are not careful, your entire margin account could quickly be wiped out.  If your margin account is 1% and the currency moves just one cent against you, you lose $1000.

FOREX trading, however, has several methods to limit loss.  Stop loss orders automatically close your position if the value of the currency crosses a pre-determined point.  Stop loss orders allow you to limit your losses to a specified amount while still allowing potential profit taking. 

An often overlooked risk is the possibility that your broker may close your position if your potential losses approach the balance of your margin account.  You may be riding out a down trend with the expectations of a market reversal, but unless you replenish your margin account you may find your position has been closed.  If this happens, you lose all of your margin.

For example:

You sell EUR/USD at 1.2144 (sell 100,000 euros and buy 121,440 US dollars) with the expectation that the euro will fall in price.  You have a 1% margin account which means the required margin is $1,214.40.  You have $1250 in your margin account, so to enter this position your margin account is left with $35.60.

You have not specified a stop loss order, and after you enter this position the euro suddenly rallies, gaining 0.0263 for a price of 1.2407.  100,000 euros are now worth US$124,070 and your 1% margin requirements have risen to $1,240.70.  Depending on the policy of your broker, your position may be automatically closed or the extra funds in your margin account may be used to make up the difference.  In any case, if the euro continues to gain value and you wish to ride it out (bad idea) you will have to add more funds to your margin account or risk losing everything.

Another example:

You buy USD/CHF at 1.2623 with the expectation that the US dollar will gain against the Swiss franc.  You buy a standard lot of 100,000 American dollars for 126,230 Swiss francs with a margin requirement of 1% or $1,000.

As expected, the US dollar rises to 1.2683 at which point you close your position.  You sell 100,000 American dollars for 126,830 Swiss francs for a profit of 600 francs or US$473.08 (600 francs divided by the exchange rate of 1.2683).

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Introduction to Online Forex Trading
Current Forex Currency Rates
Forex Trading
How to Get Started In FOREX Trading
FOREX versus Futures Market
FOREX versus Stocks
FOREX Trading Philosophy
FOREX Tools
Fundamental Analysis In Forex Trading
Forex Technical Analysis - Part 1
Forex Technical Analysis - Part 2
FOREX Trading Strategies
Trading Currencies on Margin
Currency Option Marketplace
FOREX Signals
How to Read FOREX Quotes
Calculating FOREX Profits and Losses
Risks of FOREX Trading
FOREX Training
FOREX Trading Software
FOREX Brokers
FOREX Glossary
Forex Updates and Training
Crash Course in Forex Education
How to Recognize Patterns in Forex Trading Markets
Defining Exotic Currencies and Their Impact on Forex Markets
Defining Trading Trend and Ranges in Forex Trading
Mind Games – The Psychology of Forex Market Trading
Crossing Currency - What’s This Mean to Forex Traders
Money Management Basics for Forex Traders
Choosing Your Forex Broker
Expensive Beginner Forex Trader Mistakes
The Elliott Wave Theory for Forex Markets
Failsafe Facts to Guarantee Failure in Forex Trading
Five No Nonsense Strategies in Forex Trading
Global Expansion and It’s Reaches within the Forex Market
Hedging in the Forex Market
The Important Ways to Keep From Losing in the Forex Markets
An Overview of the Euro’s Performance in the Forex Markets
Six Trading Tips for the Forex Newbie
The Lowdown on Day Trading
Interpreting How Interest Rates Drive the Foreign Exchange Markets
The Basics of the Bollinger Band Technical Indicator in Forex Markets
Relative Strength Analysis in Forex Trading
The Basics on Understanding Forex Options
Forex Charts – What Are They and How Do You Read Them
Interpreting the Future of the Oil Marketplace and How It Affects Forex Trading
Top Five Economic Indicators that Drive Forex Trading
Rules for Trading in Forex Markets
How Does the Japanese Yen Stack Up Against the US Dollar in Forex Markets
Pivot Points in Forex
The Ins and Outs of Trying Out a Forex Demo Account
The Top Currencies to Watch in the Forex Trading Game
Defining Moments Regarding Trading Trends and Ranges with Forex
Top Ten Basic Terms in Forex Trading and Their Definitions
Forex Folklore Investment Myths in the Market
Five Economic Driving Forces that Influence Forex Trading
Day Trading All You Wish You Did Not Have to Know
Time line for Daily Forex Trading When are the Optimum Moments
Forex Relative Strength Analysis
How Forex Quotes Can Influence your Trading Tactics
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