subject: Forex Trading Strategies: Trading On The Margin [print this page] In the modern world of Forex trading, leverage is often one of the features of an account a broker wil advertise. To put it plainly, Forex traders use leverage as a means of placing a high value trade whilst only risking a fraction of it. It is commonplace to find brokers advertising leverage of 100:1. Simply put, your broker will allow you to trade 100 times what you actually deposit.
In this example, the broker is saying that he will lend' you the money to make your trade, if you put forward 1% of that trade as a security against it. That 1% is called a margin: the percentage of the total trade required as collateral. This 1%, when expressed as leverage becomes 100:1 (a security of 1 is required for every 100 traded). Some brokers offer even greater leverage, such as 200:1 and 400:1 (which expressed as margins are 0.5% and 0.25% respectively).
So by using leverage as aforex trading strategy, you could control a trade worth $100,000 with only $1000 at risk when the quoted leverage is 100:1. For someone looking to start a career in Forex trading, but has limited funds to begin with, this would seem like a gift from heaven.
One key element that many brokers may neglect to mention, is that the leverage they quoted is actually the maximum available to you. You don't actually have to use all of it. In fact, it is best to use as little as you can, because the more leverage you use, the more you are at risk from fluctuations in your trade value.
Going back to our example using a 1% margin to buy lots to the value of $100,000 (leveraging your $1000 by 100%). You now have open trades worth $100,000, but only a breathing space of $1000. If your lots fell in value by a mere 1%, your $1000 would be wiped out and your broker would make a margin call' (this means some or all of your trades would be closed automatically).
Putting in place a stop loss is a common tactic used here, but with this much leverage you will only give yourself even less room to breath. So far we havent even mentioned your brokers spread, which would more or less leave you unable to suffer the smallest move against you. Sure, your lots may increase in value, even by enough to make a profit after the spread. However, Forex markets can be volatile and your lots could easily dip below your stop loss before turning around and becoming profitable. Because you were too heavily leveraged, your trade closed at a loss because you had no room to breathe.
Sensible traders will not leverage their accounts too heavily. Instead of taking the maximum 100:1 on offer, it would be far more prudent to take say 20:1 (which would be a 5% margin).
With this example, you would now control lots to a value of $20,000, and they would have to fall by 5% in value for your broker to make a margin call. You can now place a stop loss that gives you room for a possible dip without your trades closing out before they turn into profit.
Forex margin trading will always be a useful tool to allow traders to increase their capacity to trade, but for the inexperienced trader it can be a hard lesson in how a small movement in the market against you could be disastrous. When used correctly, a leveraged account gives the average man in the street the opportunity to trade in lots that would have otherwise been out of his reach. The important things to remember when using leverage is that you should not allow your account to become too heavily leveraged and that it should be used as a tool to give you an advantage in the market, not your broker.
