Learn about Forex
Trading on Margin
Welcome to the fourth in this short FX Education series, aimed at introducing new investors to the basic concepts of FX trading. In this edition we describe trading on margin.
Defining Margin
Trading on margin means that an investor can buy and sell assets that represent more value than the capital in their account. Forex trading is typically executed on margin, and the industry practice is to trade on relatively small margin amounts since currency exchange rate fluctuations tend to be less than one or two percent on any given day.
Margin, or leverage, implies that the investor is "gearing" his or her funds. Margin rates of 1% on the first EUR 50,000 in your account, and 2% on assets greater than that, are common in online trading. What this means is that a margin of 1.0% enables one to trade up to EUR 1,000,000 even though there is EUR 10,000 in the account. In terms of leverage this corresponds to 100:1, because 100 times EUR 10,000 is EUR 1,000,000, or put another way, EUR 10,000 is 1.0% of EUR 1,000,000.
Margin is a powerful accelerator
Using leverage opens the possibility to generate profits quickly, but increases the risk of rapidly incurring large losses. It is important to review the margin thresholds and limitations in your trading agreement to determine the range of trading activities you can undertake.
Net Equity for Margin
This term is the absolute indicator of the extent of margin capability in your account. If your Margin Required exceeds your Net Equity for Margin you must close or reduce positions, or send additional funds to cover your positions.
Trading on Unrealized Profits
You can trade on unrealized profits in your account. Margin calculations are based on the Net Equity for Margin which includes such unrealized profits and losses as are current in your account.
Margin call
Traders must maintain the margins listed in their account at all times. If funds in an account fall below the margin requirement, a margin call is issued. A margin call requires the trader to immediately deposit more funds to cover the position or to close the position.
Trade size
The amount of the trade size is limited by the margin position. For example, a trader with EUR 10,000 in funds and 1% margin, can trade as much as EUR 1,000,000; however taking a single position in this amount would be extremely unwise and generate a margin call if the trade were to tilt slightly.
Majors, Minors and Exotics
Margin rates vary according to the liquidity (available inventory) of different currency crosses. Lower rates apply to Majors, higher rates to minors, and then highest margin terms for exotics.