Foreign Exchange Margin Trading: Earn More Profits With Less Putting Into Use Your Broker's Capital
Foreign exchange margin trading is a method of using leverage to multiply the purchasing power of your account equity. Leverage actually means using a small sum to control a much larger sum. This is attainable because it is unlikely that the quote of a currency will vary by more than some 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 price may change. Your broker will in effect 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 lot more leverage in the forex markets. Depending on your broker's terms, you may be able to control 50, 100 or even 200 times your trading equity.
This may produce great gains if you are nimble, but it can also mean big losses if not. Generally, the more 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 currency market is shown as GBP/USD 1.7100. So to purchase one British pound you would need $1.71. If you predicted the price of the dollar to rise against the pound you might 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 increase.
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 garnered a profit of 2.9% less the spread. 2.9% of $100,000 is $2,900, so that would be an outstanding trade.
But most individuals do not have $100,000 spare cash that we can use to trade on the foreign exchange markets. So here is where the principle of forex margins comes into play.
As you are buying and selling different currencies at the same time, your own funds merely has to cover any loss that you will probably make if the dollar falls instead of rising. And you would use 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.
In fact many brokers now operate limited risk amounts where the account 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 currency trading that you will soon do it without even thinking about it. Still it is important to keep in mind the risks. Lower leverage is always 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 a lot of 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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