Forex Trading Margin
The advantage of using the forex trading margin
Without margin, forex trading would be way beyond the reach of the average investor like me and you. So, you have to know, what exactly is forex trading margin and how does it work?
Forex 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 forex broker to control foreighn currency lots which are usually worth about $100,000. The amount of borrowing power your margin account gives you is the leverage. Leverage is normally expressed as a ratio, for example a leverage of 100:1 means you can control assets worth 100 times your deposit.
What this means exactly in forex trading is that with a 1% margin account you can control standard lots of $100,000 with a $1,000 deposit. Trading forex on a margin increases both profits and losses. There is the possibility for the trader to lose more than his original deposit. However with proper forex trading safeguards loss can be limited. Normally forex brokers terminates a transaction that goes beyond the margin deposit.
The Benefits of Forex trading margin
Trading forex on a margin gives you more buying power and the potential for more profits and also losses. How does this work, exactly? A 1% margin account allows you to control a currency lot of $100,000 for $1,000. When trading forex with $100,000 a little change 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 that goes down to 4 decimal places. Instead of saying $1.32, forex trading 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 (This applies if you are trading American dollars).
For example, 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 forex trading margin, if you had $1000 of currency, the price change from 1.3256 to 1.3356 represents a difference of $10. This might be Significant to the tourist, perhaps, but not the investor.
So the real advantage of margin is the possibility of increased profit potential.