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 them. This method basically permits you to control huge amounts of money by using only a small sum. Generally, currency values won’t rise or drop over a certain percentage within a set time frame, and this is why is 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 your 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, due to the particularities of the exchange market, your leverage will undoubtedly be far greater when dealing with currencies. You can control up to up to 200 times your actual balance – of course, with regards to the terms imposed by your broker. Needless to say that this may let you turn big profits, however you are also risking more. Generally of the thumb, the chance factor increases as you utilize 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 one 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 will be trading six digit amounts – most people simply cannot afford to trade with this scale. Which is where we can utilize the principle behind Forex margin trading. You only need to supply the amount which may cover the losses if the dollar could have dropped instead of rising in the last example – if you have the $2,900 in your account, the broker will guarantee the remaining $97,100 for the purchase.
Currently, many brokers cope with limited risk amounts – which means that they handle accounts which automatically stop the trades if you have lost your funds, effectively preventing the trader from losing more than they have through disastrous margin calls.
This Forex margin trading approach to using leverage is very common in forex trading nowadays. It’s very likely that you will do it soon without so much as a single considered it – however, you should always remember the high risks associated with a lot of leverage, in fact it is recommended that you never utilize the maximum margin allowed by your broker.