| Forex margin trading is a way of applying leverage to | | | | you sell your dollars now and buy back into pounds, |
| increase the purchasing power of your money. | | | | you will have made a profit of 2.9% less the spread. |
| Leverage simply means using a small sum to control a | | | | 2.9% of $100,000 is $2,900, so that would be an |
| much larger sum. This is possible because it is unlikely | | | | excellent trade. |
| that the value of a currency will change by more | | | | But most of us do not have $100,000 spare cash |
| than a certain percentage over a short time. So you | | | | that we want to trade on the currency exchange |
| can place a few hundred dollars in your brokerage | | | | market. So here is where the principle of forex |
| account to trade on the margin - the amount that | | | | margins comes into play. |
| you think the price will fall. Your broker will in effect | | | | Since you are buying and selling different currencies |
| lend you the balance. | | | | at the same time, your own money only has to |
| Trading on margins is also known in stock and | | | | cover any loss that you might make if the dollar falls |
| futures trading, but because of the special nature of | | | | instead of rising. And you would put a stop loss into |
| currencies, you can get a lot more leverage in the | | | | place to limit that loss, so $1,000 might be all you |
| forex market. Depending on your broker's terms, you | | | | needed to have in your account to make this |
| may be able to control 50, 100 or even 200 times | | | | $100,000 purchase. Your broker guarantees the other |
| your account balance. | | | | $99,000. |
| This can lead to big profits if you are successful, but | | | | In fact many brokers now operate limited risk |
| it can also mean big losses if not. In general, the | | | | amounts where the account will automatically close |
| more leverage you use, the more risky your trading | | | | out the trade if whatever funds you have in your |
| is. | | | | account are lost. This prevents margin calls which can |
| We can understand leverage and margins if we | | | | be disastrous for a trader because they mean that |
| consider an example. | | | | you can lose more than you have. But with a forex |
| Imagine that the current rate on the British pound to | | | | limited risk account that is not a possibility. The |
| US dollar forex market is shown as GBP/USD 1.7100. | | | | broker's software that you use to control your |
| So to buy one British pound you would need $1.71. If | | | | account will not let you lose more than your account |
| you expected the value of the dollar to rise against | | | | balance. |
| the pound you might decide to sell enough pounds to | | | | Using leverage in this way is so common in currency |
| buy $100,000. If your broker used lots of $10,000 | | | | trading that you will soon do it without even thinking |
| each, this would be 10 lots. Then you would sit back | | | | about it. Still it is important to keep in mind the risks. |
| and wait for the price to go up. | | | | Lower leverage is always safer and you may never |
| A few days later you might find that the price had | | | | want to go to the maximum forex margin that your |
| moved to GBP/USD 1.6600. Sure enough, the dollar | | | | broker would allow. |
| has risen and the pound is now worth only $1.66. If | | | | |