Margin and leverage are among the most important concepts to understand when trading forex. These essential tools allow forex traders to control trading positions that are substantially greater in size than would be the case without the use of these tools. It is important for inexperienced traders and who are new to trading, on any financial markets, to completely understand the concepts of leverage and margin. Too often new traders are impatient to begin trading and fail to grasp the importance and impact these two critical success factors will have on the outcome of their potential success.
Trading with leverage allows traders to enter markets that would be otherwise restricted based on their account size. Leverage allows traders to open positions for more lots, more contracts, more shares etc. than they would otherwise be able to afford. This is a concept that carries a high degree of risk, but since forex prices move very slowly (in terms of the actual change in value), the vast majority of traders leverage their accounts when engaging in short-term trading.
Most forex brokers allow a very high leverage ratio, or, to put it differently, have very low margin requirements. This is why profits and losses can be so great in forex trading even though the actual prices of the currencies themselves do not change all that much—certainly not like stocks. Stocks can double or triple in price, or fall to zero; currency never does. Because currency prices do not vary substantially, much lower margin requirements is less risky than it would be for stocks.
Using margin in forex trading is a new concept for many traders and one that is often misunderstood. Margin is a good faith deposit that a trader puts up for collateral to hold open a position. More often than not margin gets confused as a fee to a trader. It is actually not a transaction cost, but a portion of your account equity set aside and allocated as a margin deposit. When trading with margin it is important to remember that the amount of margin needed to hold open a position will ultimately be determined by trade size. As trade size increases your margin requirement will increase as well.
A margin call is perhaps one of the biggest nightmares forex traders can have. This happens when your broker informs you that your margin deposits have simply fallen below the required minimum level owing to the fact the open position has moved against you. Trading on margin can be a profitable forex strategy, but it is important to understand all the possible risks. You should make sure you know how your margin account operates, and be sure to read the margin agreement between you and your selected broker.
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