Forex Margin Trading: Make Higher Profits With Less Putting Into Use Your Broker's Money
Foreign exchange margin trading is a way of applying leverage to enhance the purchasing power of your money. Leverage basically means using a small amount to control a much larger amount. This is practicable because it is unlikely that the rate of a currency will move by more than a few percentage points within a short time. So you can deposit 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 practically lend you the difference.
Trading on margins is also known in stock and futures trading, but due to the special nature of currencies, you can use a much higher leverage in the currency markets. Depending on your broker's terms, you could be able to control 50, 100 or even 200 times your trading capital.
This could lead to large profits if you are nimble, but it can also result in big losses if not. As a rule, the higher leverage you use, the more risky your trading is.
We can understand leverage and margins through an example.
Imagine that the current rate on the British pound to US dollar foreign exchange market is shown as GBP/USD 1.7100. So to purchase one British pound you would need $1.71. If you hoped for the value of the dollar to surge 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 move up.
A few 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 earned 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 forex markets. So here is where the essence of margin trading comes into play.
Because you are buying and selling different currencies at the same time, your own capital just has to cover any loss that you may perhaps 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 transaction. Your broker guarantees the other $99,000.
Actually most brokers now operate limited risk amounts where the system will automatically close out the trade if whatever funds you have in your account are lost. This prevents margin calls which can be destructive 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 account balance.
Using leverage in this way is so widespread 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 invariably safer and you may never want to go to the maximum forex margin that your broker would allow. You may also reduce your risk by using highly reliable forex signals. There are numerous 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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