Making Forex Trading Margins Effective

In forex trading we'd hear of margin accounts that enable forex players go trading better and more confidently. And along the margin accounts are leverages in forex trading. Just what are margins and leverages?

Margin accounts established with forex brokers enable forex trading players to control hefty currencies with minimal capital deposit. Forex brokers allow investors to borrow money from them (called leveraging) so that trading in currency lots becomes more controllable. So instead of just having $100 to invest, leveraging gives the investor something like a 100:1 chance of controlling more capital. A 100:1 ratio of leverage means for every dollar one invests, the broker lends $100.

In forex trading, currencies are often dealt in smaller values than their cash equivalent. Dollars are treated four decimal places lower. Like, an investment of, say, $1.32 is seen as $1.3256. The smallest values are known as pips in forex trading. Often a pip (when trading with US dollars) is worth something like $10. Thus, with leveraging, it's as easy to earn as it is easy to lose money. If the margin account in forex trading is 1% and the currency one trades in suddenly falls several cents, $1,000 is lost, just like that. Or, if the currency gains several cents, the profit shoots to $1,000. Thus, one safety measure is a stop loss order.

So, for instance, we sell currencies EUR/USD at some 1.2144---meaning we trade 100,000 euros and purchase 121,440 dollars---anticipating a fall in euros. And say we have a 1% margin account with our broker, meaning the needed margin is $1,214.40. Having $1,250 in our margin account, in order for us to satisfy the above forex trading conditions, we need to release from our margin account so that we are left with $35.60.

If there's no stop loss order yet at this point, once the euro gains power and increases in value---earning some 0.0263 for an investment of 1.2407---100,000 euros may now be valued at US $124, 070. Our 1% margin pre-requisite increases to $1,240.70. The broker may decide to quit then or increase investment to make up for the loss. Should we decide to continue trading and increase investment to make up for the gains that the euro had, we may lose more, if not everything.

Forex trading margin accounts must have a good interplay with other forex tools, like a stop loss order, to be effective. In the example above, a stop loss order could have minimized the forex trading loss.