Trading the foreign exchange market with forex margin
By: Amit Achameesing
Submitted: 2010-08-27 17:09:19 | Word Count: 698
The breakthrough in currency trading has come from forex margin whereby small retail traders are making the most of the small amount of money they have.Until the late 1990's foreign currency trading was within the reach of only big banks and other large financial institutions.The notion of margin comes from the equity market and now allows everyone who is interested to trade the currency market.However, a large majority of traders lose because they do not understand how this key concept works.
Forex Margin is usually defined as the fraction of the total value of currencies that a person wants to trade. Basically if you want to trade $100,000 worth of currencies you should put $1000 as forex margin with your forex broker. Put in a techical way your trading capital has been leveraged by 100 times.
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Generally the online forex brokers will display their quotes for a currency pair in the following way:GBP/USD. If GBP/USD is trading at 1.5000 then it means that one British Pound is worth 1.5000 US Dollars. Now if you want to buy 10,000 Pounds it means that you will have to sell 15,000 USD. Basically your margin required will be 1% of $15,000 which equals $150.00. As you can see here with only a small amount of money you are able to buy a much larger amount of currencies.
Now let us see how this can work against the small retail trader.
In the hypothetical example which follows we will make a few assumptions. First there are two forex brokers namely A and B and their margin requirements are not the same. For broker A it is 2% whereas for broker B it is 1%. Second we assume that with each of these two brokers you have $ 5,000. Third the price of the GBP/USD is trading at 1.5000 such that a one pip move of 0.0001 is worth one dollar. Finally you will be willing to put $ 300 as margin on each trade
From the above assumption given that broker A requires a margin of 2%, to buy or long one mini lot of GBP/USD you will thus put your $300 (2% x 15000) of margin. But with broker B given the margin required is 1 % you will need to put only $150 and so you buy 2 lots. Suppose that luck is not on your side and instead of going up the GBP/USD falls by 50 pips.. The following happens: you lose $50 ($1 x 50 pips x 1 lot) with broker A but with broker B you lose twice more, that is, $100 ($1 x 50 pips x 2 lots).
So with broker A you have leveraged your account by 50 times but with broker B you have leveraged your account by 100 times.The most important point that you must grasp here is that with Broker A less risks are involved because you have leveraged your account by only 50 times..This has been indeed the basic argument for the recent proposition of the Commodity Futures Trading Commission (CFTC)
Indeed in January 2010 the CFTC has made it clear that it wants to reduce leverage in the forex retail industry to 10-1. . The proposition by the CFTC for more regulations in retail forex comes from the authority granted to it by US law makers in the Farm Bill.. If this proposal is enacted this means that the potenial of forex margin will be drastically reduced so much so that small retail traders will have to give more funds to the forex brokers to trade the same amount of currencies..
Author Resource:-
To learn everything about forex margin it is important that you also see how forex margin works in a forex trading account. Visit the following link and you will be taken to YouTube where you can watch forex margin live from a forex expert Amit Achameesing.
