Currency Margin Trading: Make More Profits With Less Borrowing Your Broker's Capital

By Erina Array

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Foreign exchange margin trading is a method of using leverage to enhance the purchasing power of your account equity. Leverage actually means using a small amount to control a much larger amount. This is viable because it is unlikely that the quote of a currency will fluctuate by more than a few percentage points within a short time. So you could 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 equities and commodities trading, but due to the special nature of currencies, you may 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 equity.

This could produce large gains if you are nimble, but it can also result in big losses if not. All things considered, the higher leverage you use, the more risky your trading is.

We can understand leverage and margins through an example.

Assume 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 anticipated the price of the dollar to soar against the pound you could 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.

Some 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 fantastic trade.

But most traders do not have $100,000 spare cash that we can use to trade on the foreign exchange 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 funds simply has to cover any loss that you might possibly make if the dollar falls instead of rising. And you would set a stop loss to limit that loss, so $1,000 could be all you needed to have in your account to make this $100,000 deal. 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 ruinous for a trader because they mean that you may lose more than you have. But with a forex limited risk account that is impossible. The broker's platform that you use to control your account will not let you lose more than your margin equity.

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 keep in mind the fact, that not all forex signals are winners, so don't bet too much on any single position.

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