Margin and Leverage Trading
There are several risks you must account for when actively trading a forex portfolio. The forex markets allow traders to leverage a considerable amount of money which can generate large profits or incur tremendous loses. Forex trading and risk factors go hand in hand and the better you understand what these risks are and how they can be monitored, the more profitable you will be as a forex trader.
Margin or leverage risk plays a significant role when trading the forex markets. What exactly is margin trading? When utilizing margin you should think about the term leverage. In reality, margin trading and the use of leverage go hand in hand when it comes to understanding the practice.
Usually, when you are placing a forex trade, it is necessary for you to shell out a minimum amount of the position in good faith. When you put up a small amount of capital, and are able to amplify the size of your forex position, your trade is considered to be leveraged. The cost in terms of dollars which is required to be placed is deemed as the margin requirement. Many forex brokers allow their forex trading partners to leverage up to 100:1. The money that you put up is referred to a collateral, which is the equity you have when you place a trade. It is similar to borrowing money when you purchase a home, as the bank requires a specific amount of collateral to allow you to make the purchase.
The equity that you put up is referred to as initial margin. If your broker has a leverage profile of 20:1, then for every dollar you put up, the broker will lend you $20 to place a trade. Your broker will charge you an interest fee to borrow the capital. Again, when you are trading the forex markets and working with margin you should be thinking of the smallest amount of money you can utilize or pony up to leverage and maximize the position.
Margin trading can be very lucrative, but it can also be very costly. The issues that traders run into when using margin, is that you can easily lose your equity. For example, imagine you place a trade where you put up $50 dollars, and your broker allows you to leverage your trade at 100:1. The trade you would be able to place is on $5,000. On this trade, if you lose 1% on your trade, you would lose the entire equity on your trade. Granted this would be a robust loss in forex, as you would need to lose .013 on a EUR/USD trade when the currency pair is trading at 1.30.
If you had this type of trade on your broker would come to you and require you to post capital in your account which would allow you to keep the trade open. If you were not able to post additional capital, which is referred to a maintenance margin, your broker could terminate your trade without any warning.