Forex Margin

...Using forex margin there is also possibility of increased loss potential.

As there is a possibility of increased profit potential when using forex margin, there is also a possibility of increased loss potential. If you are not careful, your entire margin account could quickly be wiped out. Let's take for example, your margin account is 1% and if the currency moves just one cent against you, you will lose $1000.

Forex trading, however, has several methods to limit loss. Which are; Stop Loss orders: Stop loss orders automatically close your position if the value of the currency crosses a pre-determined point. Stop loss orders allows 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 loss approaches 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 forex margin account you may find out that your position has been closed. If this happens, you lose all of your forex trading margin.

For example: If 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. So you have about $1250 in your margin account, and if you enter this position your margin account will be left with $35.60.

If you enter this position without specifying a stop loss order, and after the euro suddenly goes up, 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. It will depend on the policy of your forex broker, your position may be closed or the remaining funds in your forex 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, which I think is a bad idea, you will have to add more funds to your margin account or risk losing everything.

Another example: Let's say 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).