Forex Margin Trading – What You Need to Know About Leverage

There are several methods to apply leverage through which it is possible to increase the actual purchasing power of one’s investment, and Forex margin trading is one of these. This method basically permits you to control large amounts of money by using only a small sum. Generally, currency values will not rise or drop over a particular percentage within a set time frame, and this is what makes this method viable. In practice, you are able to trade on the margin through the use of just a small amount, which may cover the difference between the current price and the possible future lowest value, practically loaning the difference from your own broker.
The idea behind Forex margin trading can be encountered in futures or stock trading as well. However, as a result of particularities of the exchange market, your leverage will be far greater when dealing with currencies. You can control as much as around 200 times your actual balance – of course, with regards to the terms imposed by your broker. Obviously that this may permit you to turn big profits, however you are also risking more. Generally of the thumb, the risk factor increases as you utilize more leverage.
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To give you an example of leverage, think about the following scenario:
The going exchange rate between the pound sterling and the U.S. dollar is GBP/USD 1.71 ($1.71 for one pound sterling). You’re expecting the relative value of the U.S. dollar to go up, and buy $100,000. A couple of days later, the going rate is GBP/USD 1.66 – the pound sterling has dropped, and something pound is currently worth only $1.66. If you were to trade your dollars back for pounds, you’ll obtain 2.9% of one’s investment as profit (less the spread); that’s, a $2,900 benefit from the transaction.
In reality, it is unlikely you are trading six digit amounts – most of us simply cannot afford to trade with this scale. Which is where we can utilize the principle behind Forex margin trading. You merely need to provide the amount which would cover the losses if the dollar would have dropped instead of rising in the last example – if you have the $2,900 in your account, the broker will guarantee the rest of the $97,100 for the purchase.
Currently, many brokers cope with limited risk amounts – which means that they handle accounts which automatically stop the trades when you have lost your funds, effectively preventing the trader from losing more than they have through disastrous margin calls.

This Forex margin trading method of using leverage is very common in forex trading nowadays. It’s very likely that you’ll do it in the near future without so much as a single thought about it – however, it is best to keep in mind the high risks associated with a lot of leverage, and it is recommended that you never utilize the maximum margin allowed by your broker.

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