Forex Margin Trading: Make More Profits With Less Borrowing Your Broker's Money
Foreign exchange margin trading is a way of applying leverage to enhance the purchasing power of your trading capital. Leverage simply means using a small amount to control a much larger amount. This is attainable because it is not likely that the quote of a currency will change by more than a certain percentage points within a short time. So you could place a few hundred dollars in your brokerage account to trade on the margin - the amount that you think the rate could change. Your broker will in effect provide you the difference.
Trading on margins is also known in stock and futures trading, but due to the special nature of currencies, you can get a much higher leverage in the foreign exchange markets. Depending on your broker's terms, you may be able to trade with 50, 100 or even 200 times your trading equity.
This can lead to large gains if you are successful, but it can also result in big losses if not. Usually, the more leverage you use, the riskier your trading is.
We can understand leverage and margins through 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 purchase one British pound you would need $1.71. If you predicted the value of the dollar to increase against the pound you may 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 couple of days later you might find that the rate 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 a great trade.
But most traders do not have $100,000 spare cash that we want to trade on the currency exchange markets. So here is where the essence of margin trading comes into play.
Since you are buying and selling various currencies at the same time, your own funds only has to cover any loss that you may possibly make if the dollar falls instead of rising. And you would set a stop loss 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.
Actually most brokers now operate limited risk amounts where the account will automatically close out the position if whatever funds you have in your account are lost. This prevents margin calls which can be ruinous 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 platform that you use to control your account will not let you lose more than your trading capital.
Using leverage in this way is so common in forex trading that you will soon do it without even thinking about it. Still it is important to bear in mind the risks. Lower leverage is always safer and you may never want to go to the highest degree forex margin that your broker would allow. You may also reduce your risk by using highly reliable forex signals. There are many forex signal providers available online. But be aware of the fact, that not all forex signals are winners, so don't bet too much on any single trade.
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