Leverage
in Currency Trading
Leverage financed with credit, such as that purchased
on a margin account is very common in Forex. A
margined account is a leverageable account in
which Forex can be purchased for a combination
of cash or collateral depending what your brokers
will accept.
The loan (leverage) in the margined account
is collateralized by your initial margin (deposit),
if the value of the trade (position) drops sufficiently,
the broker will ask you to either put in more
cash, or sell a portion of your position or even
close your position.
Margin rules may be regulated in some countries,
but margin requirements and interest vary among
broker/dealers so always check with the company
you are dealing with to ensure you understand
their policy.
Up until this point you are probably wondering
how a small investor can trade such large amounts
of money (positions). The amount of leverage you
use will depend on your broker and what you feel
comfortable with. There was a time when it was
difficult to find companies prepared to offer
margined accounts but nowadays you can get leverage
from a high as 1% with some brokers. This means
you could control $100,000 with only $1,000.
Typically the broker will have a minimum account
size also known as account margin or initial margin
e.g. $10,000. Once you have deposited your money
you will then be able to trade. The broker will
also stipulate how much they require per position
(lot) traded.
In the example above for every $1,000 you have
you can take a lot of $100,000 so if you have
$5,000 they may allow you to trade up to $500,00
of forex.
The minimum security (Margin) for each lot will
very from broker to broker. In the example above
the broker required a one percent margin. This
means that for every $100,000 traded the broker
wanted $1,000 as security on the position.
Margin call is also something that you will
have to be aware of. If for any reason the broker
thinks that your position is in danger e.g. you
have a position of $100,000 with a margin of one
percent ($1,000) and your losses are approaching
your margin ($1,000). He will call you and either
ask you to deposit more money, or close your position
to limit your risk and his risk.
If you are going to trade on a margin account
it is imperative that you talk with your broker
first to find out what their polices are on this
type of accounts.
Variation Margin is also very important. Variation
margin is the amount of profit or loss your account
is showing on open positions.
Let's say you have just deposited $10,000 with
your broker. You take 5 lots of USD/JPY, which
is $500,000. To secure this the broker needs $5,000
(1%).
The trade goes bad and your losses equal $5001,
your broker may do a margin call. The reason he
may do a margin call is that even though you still
have $4,999 in your account the broker needs that
as security and allowing you to use it could endanger
yourself and him.
Another way to look at it is this, if you have
an account of $10,000 and you have a 1 lot ($100,000)
position. That's $1,000 assuming a (1% margin)
is no longer available for you to trade. The money
still belongs to you but for the time you are
margined the broker needs that as security.
Another point of note is that some brokers may
require a higher margin during the weekends. This
may take the form of 1% margin during the week
and if you intend to hold the position over the
weekend it may rise to 2% or higher. Also in the
example we have used a 1% margin. This is by no
means standard. I have seen as high as 0.5% and
many between 3%-5% margin. It all depends on your
broker.
There have been many discussions on the topic
of margin and some argue that too much margin
is dangerous. This is a point for the individual
concerned. The important thing to remember as
with all trading is that you thoroughly understand
your broker's policies on the subject and you
are comfortable with and understand your risk.
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