Leverage Your FOREX Account
Using an account financed with credit, such as that in a margin account is very common in
the Forex market.
A margined account is an account in which the amount of cash available to trade Forex has been
considerably increased over the actual real cash in the account. The ratio of available trading cash to actual
real cash is the leverage on the account.
This concept is very common in stock trading accounts where you can usually "borrow" up to
100% of the cash in your account, in that case you would have a 50% margined account because the ratio of
cash/(cash+borrowed cash) is 50%. There are also usually strict rules about the type of stock that you can buy in a
margin account, such as no less than $5 stocks etc. This is also called a 2:1 leverage.
The amount of stocks that can be purchased for a combination of your cash and borrowed money will
depend on what your
brokers margin rules are.
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 will
always vary among broker/dealers so always
check with the company you are dealing with to ensure you understand their policy.
Getting back to the FOREX market and the $100,000 contract size you are probably wondering how a small investor can trade such large amounts of money
(positions). In the FOREX market it is common for brokers to allow a 100:1 leverage, and in some cases a
200:1 leverage.
The amount
of leverage you can 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% (100:1) with some
brokerages. 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,
or more typically $2,000.
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 (she!) 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 account. Having said that, the chances are that this will all happen electronically and that your
position will be closed automatically, if you don't employ a stop loss.
Variation Margin is also very important, this 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 point of note is that some brokers may
require a higher
margin at 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. Remember, The FOREX market is closed for much of the weekend, depending on
where you live in the world. Also in the example we have used a 1% margin. This is by no means standard,
margins as
high as 0.5% and many between 3%-5% margin are used. 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
brokers policies on
the subject and you are comfortable with and understand your risk.
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