What Does Trading Forex On Margin Mean. Learn To Reap The Rewards At Minimal Risk!

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

For starters, Forex on margin allows 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. For example a leverage of 100:1 which 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 Forex 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 Forex brokers will terminate a transaction that extends beyond the margin deposit.

As we mentioned above, trading Forex on margin gives you more buying power and the potential for more profits (and losses). How does this work, exactly? Well 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 immediately we can see that the benefit of margin is increased profit potential.

But with benefits there will be risks and potential for loss as well. 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.

Forex On Margin