Margin and the Forex Trader

One of the first things you hear about when you start to learn Forex trading is margin - the key to Forex trading. Margin is basically credit which allows you to control blocks of currency. Without margin, the average Forex trader would not be able to play the Forex market.

When a Forex trader opens an account with a broker, he or she is given a margin account. A 1% margin account, for example, allows the Forex trader to control $100,000 with as little as $1000.

Margin can be expressed as either a percentage or a ratio. The example just given would be a 100:1 margin account.

Margin accounts are necessary in Forex trading because currency price movements are usually expressed in fractions of a cent. The American dollar, for example, is traded down to the fourth decimal place e.g. $1.4256, with the smallest unit having a value of $10 in a standard lot of $100,000.

This smallest unit is called the pip, so each time the currency prices rise or fall by one pip, this represents a profit or loss of $10 to the Forex trader.

Few investors have the cash to control outright a standard currency lot ($100,000 US). Without margin, the Forex market would be beyond the reach of the average investor.

Margin allows a Forex trader to trade currency with a relatively small investment. With a 1% margin account, for example, (an investment of $1000), the Forex trader could have a profit of $500 if the currency price moves 50 pips.

Risks to the Forex Trader

That profit, however, could easily be a loss if the currency market moves the wrong way. In addition, the Forex broker needs to protect their funds, so they may automatically close a position which approaches the limit of the margin.

As you learn Forex trading, you learn how to minimize your losses with the use of automated trading tools. For example, you can use the stop loss order which will automatically close a position if the currency price crosses a predetermined point.

It is essential that every Forex trader learn Forex trading tools to maximize profits and minimize loss.

Trading Example:

You buy USD/CDN at 1.1752 expecting the US dollar to gain against the Canadian dollar. A standard lot of 100,000 American dollars costs you 117,520 Canadian dollars. Your 1% margin account requires a deposit of $1000.

The US Dollar rises to 1.1802 and you close your position. You sell 100,000 American dollars for 118,020 Canadian dollars for a profit of $500 CDN or $423.66 USD.

It is important to note that most brokers require a reserve in your margin account. In this example, if the US dollar had fallen and there were no funds left in your margin account to cover the loss, most brokers would automatically close your position.