Forex Margins and Leverage

by | Feb 1, 2017 | Financial Featured

Margin is defined as a deposit you must give in order to use your leverage.  Margins in Forex are sometimes looked at as a fee to the broker but they are not.  Margins are a cash deposit made in good faith that allows you to use your broker to hold a position open and it is a portion of your capital.

Brokers tend to pool all of the margin deposits they receive in order to make purchase from an international bank. Margins are quoted in percentages of the whole purchase.  Knowing the margin your broker requires allows you to calculate how much leverage you have and that determines the size of your trades.

Sometimes you will see the term Account Margin.  That means the total amount you have in your trading account.  The Used Margin is the total sum your broker has sealed up in order to keep your current positions open.  The difference between your Account Margin and your Used Margin is your Usable Margin.

The danger of trading on margin, is that it is possible for your currencies value to go under what you have in your account.  Then you will experience what is called a margin call.  Since trading on Margin means that you are trading with way more money than you have actually put up, you are using larger quantities than you have.  This can lead to bigger profits but also larger losses.

When the amount of money in your account is not enough to cover your potential losses, you have what is called a margin call and either you have to give the broker more money or some of your open positions will be closed by the brokerage.

Trading on Margin allows you to use your leverage.  Leverage is the result of margin.  That is to say that since  your margin is a deposit that allows you to trade with a larger amounts of money than you actually have put in your account, the amount you are actually trading is called your leverage.  It is basically a way to use magnified amount of money which gives you more trading power.

Leverage can be extremely dangerous if its not being monitored properly.   Since using leverage allows you to trade in larger lots your losses can be magnified as well.  If you have two traders and both have deposited $10,000 in their accounts as their deposits. One trader chooses to use 5 to 1 leverage and the other chooses to use 50 to 1 leverage, a one PIP loss will make a much larger difference to the second trader, eating up almost his whole account.

Using leverage means that you are basically borrowing from your brokerage.  This is fine, if you will always stay ahead. That is why people say that leverage is a double edged sword.  It is great to use higher leverage when you win but when you lose it can be devastating.  If your losses based on high leverage empty your actual cash account, you will end up with a Margin Call, which is exactly the opposite of what a Forex Trader wants.

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