In our post about currency trading tips, we discussed not over-leveraging yourself with forex margin. Using the margin made available to you on the currency market in a responsible way is one of the keys to your longevity in forex trading and investing. In this post we’re going to briefly touch on what margin is, how it is used in currency trading, and how to go about using it as the tool that it is, and not abusing it as many new forex traders do.
Margin, as defined by Investopedia and in the context we’re using here, is
“1. Borrowed money that is used to purchase securities. This practice is referred to as “buying on margin”.”
In this case, the security we’re trading is foreign currency. You borrow money from your forex broker in order to purchase enough of a currency pair to make a reasonable profit. Currency pairs move in fractions of a penny called “pips” and these moves won’t provide much profit without leveraging some of your brokers borrowed money, or margin. Forex margin trading is the standard, and while it increases profits, it also increases risk and potential losses.
Forex trading margin is high compared to other markets. The typical margin with most Forex brokers is 100:1, and is standard, whether working with a real or simulated forex trading account. This can also be represented by saying the margin setting for your account is 1%, meaning for your transactions or trades, you pay 1%, while your broker pays 99%. This isn’t a fee, it is simply a way for your broker to allow you to fully participate in foreign exchange trading. In dollar terms, it means that for every $1 in your account, you have the power to buy $100 worth of currency; or you’re allowed to buy 100 times more than you deposit. This magnifies every move you make in the market, from your profits to your losses, which is why it’s very important to understand how to properly use this margin so you don’t burn through your account too quickly.
Forex margin requirements are simply that you have 1% of the amount of money you’re attempting to leverage. Some people might choose to raise their requirements to 5%, 10% or more in order to prevent accidental over-leveraging. An accidental purchase of excessive currency can cause you lose much more than your trading plan allows for. This is something seasoned traders don’t worry about, but when you’re just starting out, and not sure exactly how it all works, it’s very easy to push the boundaries beyond your comfort level, and suffer catastrophic losses as a result.
The money you deposit in a forex trading account should always only be money that you can afford to lose. This is more important in the case of Forex, because of the very high margin allowed. This high margin can cause an unexperienced, over-eager, and over-leveraged trader to quickly lose every penny in their account, and then some. A forex margin call happens when you’ve fallen below your minimum margin requirements Some brokers will offer you the opportunity to deposit more funds into your account, but often they will simply close your positions immediately. This forced margin call will not take into account stops or slippage, it simply triggers an open market order. If this occurs during some world event that is moving the market very quickly, you can suffer losses beyond the value of your account, causing you to owe your broker money. This is why trading capital must always be purely risk capital; never expect that you’ll be getting that money back. It takes a long time to learn to actually profit from any market, and the percentages say you’re more likely to lose it all, than make any money at all.
When you’re new, the responsible way to use margin is to only use a small fraction of what is available to you. Even if you’re a seasoned veteran, at that point you should have a large enough account that leveraging your account to the maximum should not be required in order for you to profit. It doesn’t matter how good you are 1:100 margin is dangerous in any hands. If you deposit $1000, and are able to purchase $100,000, that is 1 standard lot, 10 mini lots, or 100 micro lots. While you can afford to purchase those 10 mini lots with your capital, a loss is going to cause an immediate margin call. Knowing that, a new trader might just bump it down to 9 mini lots, but that’s really too much as well. A loss of 100 pips is going to crush your account with that amount of leverage. New traders should start trading 1 or 2 mini lots (given a starting capital of $1000 – go with micro lots for anything less than that), and work your way up from there. It’s understandable that you want to jump in and make money right away, but as we’ve stated, and will always state, you’re more likely to lose money. If you can’t make money trading 1 mini lot, what makes you think you’re ready to jump in with 10? Start small, and start slowly. Learn how to really trade, and adapt with the market, or perish with 90% of new traders. It’s your choice.
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