Margin trading on Forex is a financial collateral given to a broker to obtain a temporary loan with which transactions are concluded. At the same time, the trader has the right not only to buy, but also to sell currency assets at his own discretion. In this market, margin trading is directly related to leverage, which allows small and medium-sized traders to work with large lots.
Any trade should bring profit – this is the basic law of the market. Typically, this profit is the difference between all resources spent and assets received. In the stock exchange world, the concept of “profit” is interpreted differently. The fact is that the process of selling and buying securities, currencies, precious metals and raw materials is continuous.
Therefore, the static terms adopted in ordinary trading on the stock exchanges do not quite accurately convey the meaning of the concepts. To indicate the difference between the cost of different goods or one position in different time units, a special term is used here – margin.
So-called margin trading is practiced on the Forex currency exchange. This means that the trader can use the broker’s funds by providing relatively small collateral from his own deposit. This is how forex leverage works, which allows you to enter into agreements for amounts that are several times greater than the size of the player’s account.
Prospects and Possibilities of Margin Trading
- Trading in large lots with the possible receipt of large incomes without serious initial capital;
- Purchase and sale of any currencies regardless of the currency in which the deposit is opened.
Do not forget about the risks – the larger the loan amount, the greater the losses in the event of an unsuccessful deal. At the same time, it is worth taking into account the size of the spread – the broker’s commission.
To minimize risks, brokers usually set the maximum allowable lower level of margin for concluding Forex transactions. The margin in the user interface is displayed in the “Trading” section.
How to Calculate Margin
Let’s say you have one open order on the EUR/USD pair with 1 lot. When calculating the margin, the following situations may arise:
- There are no positions on your account – the margin is calculated in the standard way;
- The account has open positions with the issuance of any orders in that direction – this indicator will be the sum of the margin of both orders;
- The account has open positions with the issuance of any orders in the opposite direction – the margin is calculated for two values: for the actual position and the order being issued;
- If there are two opposite orders, this indicator is calculated separately for buying and selling.
Let’s give a more specific example. Let the exchange rate of the conditional currency pair X/Y = Z.
Where X is the base currency, Y is the quoted currency, Z is the current exchange rate. The leverage used is 1:100. Then, for a contract for 100,000 units of the base currency, the amount of the margin is calculated according to the following formula:
Z is the exchange rate between the base currency and the account currency
100,000/100 = margin in base currency
Margin*Z = margin on the account
Thus, to calculate the margin, it is necessary to divide the size of the transaction by the leverage and multiply it by the quote of the base currency. This amount will go to the broker for a loss-making contract. In order to count on your account, you need to convert the base currency to the account currency. In fact, this indicator is calculated using special online calculators offered by almost all brokerage companies.
Examples of Margin in the Stock Market
Unlike trading on the Forex market, margin trading on stock exchanges is used much less often. Margin in this case means credit funds issued by the broker for concluding transactions on short positions or buying shares. The use of such a loan is accompanied by the charging of a brokerage commission, which in the case of a long delay in the closing of contracts can amount to a very significant amount.
If we are talking about futures trading, then in this case, the margin is a collateral, from which the broker does not receive any commission.
“Pitfalls” of Margin Trading
The ability to use leverage often plays a bad joke with novice traders. Trading with borrowed funds inevitably relaxes the player, which can cause a complete “draining” of the deposit.
Emptying the account will require a new top-up, which can be difficult at the moment. And the vicious cycle of constant crediting will not lead to anything good.
To reduce the risks of own losses, brokers use a tool called a margin call – a moment when a trader needs to urgently replenish his account, otherwise current contracts will be canceled.
The average margin call is about 25% of the trader’s account. That is, if your account is equal to $1000, then with a balance of $250, the broker makes a stop-out with the closing of the current position. At the same time, the balance on the deposit will be equal to $250, which will lead to obvious losses.
So you should trade with margin on Forex as carefully as possible, using only those funds that you can spend without serious damage to your own financial situation.
Pros and Cons of Leveraged Agreements
The Main Risks of Margin Trading:
- Credit is given only for some assets. Only for liquid securities. Ask the broker for a list of assets;
- The margin can be very small or very large. It all depends on the specific asset and the requirements of the broker;
- Risk of losing investment. The more you invest, the more you can lose. A lot also depends on the deal itself: the specifics of the securities, the strategy and the market situation. Stop loss helps to minimize losses.
Advantages of Using Leverage:
- Ease of obtaining. No documents or additional legal procedures. Sometimes such a service is provided for the investor in advance;
- Any assets are suitable for collateral. Not only currency, but also securities;
- By increasing the capital, you can make profitable deals. Even without funds, a trader has the opportunity to make a significant profit;
- No commission for using the loan. The broker takes back only the amount he provided.
Margin trading seems to be made for beginners who don’t have enough finances. But novice traders shouldn’t get carried away and trade with a leverage of 1:200. Take small loans – this will gradually increase the capital and prevent you from losing the last one.
Avoiding credit is also not worth it. It is quite normal for a young businessman to take a loan from a bank and develop his business. And so on the stock exchange. When used wisely, leverage is an effective trading tool.
Conclusion
Margin trading is an important component of trading in the Forex market, which affects the size of trades and the level of profit. It is necessary to take into account, evaluate and calculate this indicator from the first steps of training.
