Forex margin trading is a way of applying leverage to increase the purchasing power of your money. Leverage simply means using a small sum to control a much larger sum. This is possible because it is unlikely that the value of a currency will change by more than a certain percentage over a short time. So you can place a few hundred dollars in your brokerage account to trade on the margin - the amount that you think the price will fall. The balance is, in effect, lent to you by the broker. Trading on margins is also known in stock and futures trading, but because of the special nature of currencies, you can get a lot more leverage in the forex market. Depending on your broker's terms, you may be able to control 50, 100 or even 200 times your account balance. This can lead to big profits if you are successful, but it can also mean big losses if not. In general, the more leverage you use, the more risky your trading is. This exemple will help you better understand this concept. Imagine that the current rate on the British pound to US dollar forex market is shown as GBP/USD 1.5100. So to buy one British pound you would need $1.51. If you expected the value of the dollar to rise against the pound you might decide to sell enough pounds to buy $100,000. Many brokers us lots of $10,000, making this trade 10 lots. Then you would sit back and wait for the price to go up. After a few days you see the price is now GBP/USD 1.4600. Just as you expected, the dollar increased in value making the pound now worth just $1.46. If you sell your dollars now and buy back into pounds, you will have made a profit of 3.3% less the spread. 3.3% of $100,000 is $3,300, so that would be an excellent trade. The problem here is that not many of us have $100,000 available to trade with. So here is where the principle of forex margins comes into play. Because you will be trading in several different currencies at any time, the money you need in your account only has to be enough to cover any potential loss. And you would put a stop loss into place to limit that loss, so $1,000 might be all you needed to have in your account to make this $100,000 purchase. The remaing $99,000 is guaranteed by the broker. 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 disastrous for a trader because they mean that you can lose more than you have. The broker's software that you use to control your account will not let you lose more than your account balance. Using leverage in this way is so common in currency trading that you will soon do it without even thinking about it. Still it is important to keep in mind the risks. It is always safer to trade with lower amounts, rather than risking large amounts on a margin.
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The forex market can be confusing for a beginner, and many are put off the market due to the high amount of money it seems you need to trade forex. Forex Margin Trading, however, makes it possible for someone to trade with a relatively low opening trading balance.
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