Foreign Exchange Margin Trading: Earn More Money With Less

English: World Money Centre - combined trading floor for the foreign exchange and international deposit & loan trading activities of National Wesminster Bank and International Westminster Bank (Photo credit: Wikipedia)

Foreign exchange margin trading can be described as a method of applying leverage to improve the purchasing power of your money. Leverage means utilizing a little amount to manage a far bigger amount. This can be possible since it is less likely which the value of the currency changes by greater than a certain percentage over a limited time. So that you can place a few hundred dollars in your brokerage account to trade around the margin - just how much for which you believe the price will fall. Your broker can essentially lend you the balance.

Currency trading on margins is usually known in stock and futures trading, nevertheless as a result of the unique character of currencies, you will get a much more leverage in the forex market. Determined by your broker's terms, you might be capable of controlling 25, 75 or even 150 times your account balance.

This could result in great profits in case you are successful, however, it may also mean big losses if not. Generally, the more leverage you have, the more dangerous your trading is.

We could understand leverage and margins when we consider a good example.

Imagine that the current rate on the British pound to US dollar forex market is shown as GBP/USD 1.8200. So to buy one British pound you would need $1.82. If you expected the value of the dollar to rise against the pound you might decide to sell enough pounds to buy $50,000. If your broker used lots of $5,000 each, this would be 10 lots. Then you would sit back and wait for the price to go up.

A few days later you might find that the price had moved to GBP/USD 1.7500. Sure enough, the dollar has risen and the pound is now worth only $1.75. If you sell your dollars now and buy back into pounds, you will have made a profit of 3.8% less the spread. 3.8% of $50,000 is $1,900, so that would be an excellent trade.

But most of us do not have $50,000 spare cash that we want to trade on the currency exchange market. So here is where the principle of forex margins comes into play.

Since you are buying and selling different currencies at the same time, your own money only has to cover any loss that you might make if the dollar falls instead of rising. And you would put a stop loss into place to limit that loss, so $1,000 might be all you needed to have in your account to make this $50,000 purchase. Your broker guarantees the other $49,000.

In fact, many brokers now operate limited risk amounts where the account will automatically close out the trade if whatever funds you have in your account are lost. This prevents margin calls which can be disastrous 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 account balance.

Using leverage in this way is so common in currency 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 always safer and you may never want to go to the maximum forex margin that your broker would allow.