There are several methods to apply leverage through which you can raise the actual purchasing power of one’s investment, and Forex margin trading is one of them. This method basically lets you control huge amounts of money by using just a small sum. Generally, currency values won’t rise or drop over a particular percentage within a set time frame, and this is why is this method viable. Used, you are able to trade on the margin through the use of just a small amount, which may cover the difference between your current price and the possible future lowest value, practically loaning the difference from your broker.
The idea behind Forex margin trading could be encountered in futures or trading as well. However, due to the particularities of the exchange market, your leverage will undoubtedly be far greater when dealing with currencies. You can control around around 200 times your actual account balance – of course, based on the terms imposed by your broker. Needless to say that this may allow you to turn big profits, nevertheless, you are also risking more. Generally of the thumb, the chance factor increases as you use more leverage.
To give you a good 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 are expecting the relative value of the U.S. dollar to rise, and buy $100,000. A few 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 hard earned money back for pounds, you would obtain 2.9% of one’s investment as profit (less the spread); that’s, a $2,900 benefit from the transaction.
In reality, it really is unlikely that you are trading six digit amounts – most people simply cannot afford to trade with this scale. And this is where we can utilize the principle behind Forex margin trading. You merely need to provide the amount which may cover the losses if the dollar would have dropped instead of rising in the previous 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 assuming you have lost your funds, effectively avoiding the trader from losing a lot more than they will have through disastrous margin calls.
This Forex margin trading method of using leverage is quite common in currency trading nowadays. It’s very likely that you will do it soon without so much as an individual considered 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 use the maximum margin allowed by your broker.