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Forex Margin Trading: Earn More Profits With Less Using Your Broker's Capital
Forex margin trading is a way of applying leverage to increase the purchasing power of your trading capital. Leverage basically means using a small amount to control a much larger sum. This is feasible because it is unlikely that the price of a currency will move by more than a certain percentage points over a short time. So you could deposit a few hundred dollars in your brokerage account to trade on the margin - the amount that you think the rate may change. Your broker will practically lend you the balance.
Trading on margins is also known in stock and futures trading, but because of the special nature of currencies, you can use a much higher leverage in the forex markets. Depending on your broker's terms, you could be able to control 50, 100 or even 200 times your trading capital.
This could lead to big gains if you are nimble, but it can also result in big losses if not. In general, the higher leverage you use, the more risky your trading is.
We can understand leverage and margins if we consider an example.
Imagine that the current rate on the British pound to US dollar forex market is shown as GBP/USD 1.7100. So to buy one British pound you would need $1.71. If you predicted the value of the dollar to move up against the pound you might decide to sell enough pounds to buy $100,000. If your broker used lots of $10,000 each, this would be 10 lots. Then you would sit back and wait for the price to soar.
A few days later you might find that the price had moved to GBP/USD 1.6600. Sure enough, the dollar has risen and the pound is now worth only $1.66. If you sell your dollars now and buy back into pounds, you will have earned a profit of 2.9% less the spread. 2.9% of $100,000 is $2,900, so that would be an excellent trade.
But most of us do not have $100,000 spare cash that we want to trade on the forex markets. So here is where the essence of forex margins comes into play.
Considering that you are buying and selling different currencies at the same time, your own cash just has to cover any loss that you could make if the dollar falls instead of rising. And you would put a stop loss to limit that loss, so $1,000 might be all you needed to have in your account to make this $100,000 transaction. Your broker guarantees the other $99,000.
Actually many brokers now operate limited risk amounts where the system will automatically close out the trade if whatever funds you have in your account are lost. This prevents margin calls which can be destructive for a trader because they mean that you can lose more than you have. But with a forex limited risk account that is not a possibility. The broker's software that you use to control your account will not let you lose more than your trading capital.
Using leverage in this way is so widespread in forex trading that you will soon do it without even thinking about it. Still it is important to keep in mind the risks. Lower leverage is invariably safer and you may never want to go to the maximum forex margin that your broker would allow. You can also reduce your risk by using highly reliable forex signals. There are numerous forex signal providers available online. But be aware of the fact, that not all forex signals are winners, so don't risk too much on any single trade.
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