The first step to properly enact forex margin trading is to sign up with either a full-service brokerage firm or an online discount broker who is capable of performing trades in the forex market. The next step to the process is to establish a margin account. The forex margin accounts are nearly identical to equities margin accounts in that the broker supplies a short-term loan for investment. The amount of leverage the investor is taking on is equal to the amount of the loan.
Forex margin trading involves using a margin account to purchase and sell foreign exchange transactions. A margin account essentially allows an investor to borrow money to increase the possible return on an investment. When an investor wants to control a larger position than they normally could with their own invested capital, they leverage borrowed money to invest in equities. These margin accounts are generally settled daily and are operated by a brokerage firm. Margin accounts can also be utilized to trade currency in the forex market. Due to the risks involved, margin trading is not for everyone and caution should be taken when implementing it into ones own forex strategy.
Depending on the margin percentage in the agreement between the investor and the broker, a money deposit needs to be made into the margin account. This process allows the investor to make actual trades. Trades that equal 100,000 currency units or more generally require a margin percentage of either one to two percent. For example, if the investor wants to trade $100,000, one percent of the transaction, in this case $1000 must be deposited into the account. The broker provides the remainder. Contract sizes for these arrangements are generally large. Since the broker will leverage 99 percent of the risk, the investor can trade in large volumes of foreign currency. The agreement also includes a delivery date, in which the investor must return the borrowed money to the broker. The broker generally does not charge interest on the borrowed amount, however, if the delivery date is not met and the account needs to be rolled over, most brokers will charge an interest rate. This rate varies and depends partially on the investor’s long or short term position as well as the interest rate of the currencies themselves.
The broker has many rights in forex margin trading in regards to their interests. The $1000 is used as a security in the margin account. If a position worsens for the investor, the broker has the right to institute a margin call. When the investor’s deposit depreciates and it begins to approach $1000 in losses, the broker instructs the investor on his or her options. First, the investor can deposit more money into the account to make up for the losses. Otherwise, the investor can close the account. This will limit the risk of further loss and secure the broker’s loan from depreciation. Most of these options are established upon the opening of the margin account.
Foreign currency is defined in trading units of U.S. dollars (USD). This occurs most commonly in increments of 10,000 USD or 100,000 USD, which are known in the industry as lots. If a single U.S. dollar is worth 130 Japanese Yen (JPY), then 10,000 USD means 1.3 million JPY. 100,000 would be 13 million. A forex margin trader purchases the currency in the form of these lots. The trader leverages the broker’s added funds, so that they can potentially make more money from the trading of these currency lots. This means that the investor can make more money from a larger trade than what was invested into the margin account, especially on revaluation gains. However, a larger loss can also be true. Essentially, each movement, either up or down, is amplified by 100.
Forex margin trading is a very specialized product offered by financial companies. It differs from foreign currency deposit in that the level of speculation is very high. Margin trading can be a lucrative, but highly dangerous market in which to invest. The potential for large scale gain is great, but many investors loose large amounts of money due to the fluctuations in world currency. Despite professional analysis, forex margin trading is at the mercy of other countries and the global economy – both of which can change overnight. Because of the number of risks involved, most investors recommend forex margin trading only for those using funds that can be exposed to risks. Investments made with retirement funds or pensions are viewed as irresponsible by most brokerage firms. Investors should always read the terms and conditions of the margin account and loan before trading.
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