subject: Learn Everything About Forex Margin. [print this page] Forex Margin has opened the doors for everyone to trade and profit from the minor fluctuations in currency prices. Until the late 1990's foreign currency trading was within the reach of only big banks and other large financial institutions.The idea of margin comes from the securities and futures market and is now giving a priceless chance to the ordinary man to invest in the currency market.However, it is important to mention that an overwhelming majority of these traders do not achieve much success in forex because they do not fully grasp how forex margin 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. So here you have multiplied or leveraged your capital by 100 times.
Every forex brokers you will see online use quotes such as GBP/USD where GBP is the base currency and USD the counter currency.. 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.
Let us now dig a little deeper to uncover the dangers of forex margin.
You have 2 trading accounts with two different brokers, Broker A has 2% margin requirement and Broker B has 1%. We consider the above example of the GBP/USD trading at 1.5000. You have a capital of $5,000 in your trading account, and trade mini 10K lots which means that when price goes up by 0.0001 or by a pip, your profit increases by $1 dollar, but if it falls by one pip you lose $1. We also assume that you want to put $300 as margin on each trade.
Given that broker A has a margin requirement of 2% to buy one lot of the GBP/USD you will need to give him $300 (2% x $15000) However broker B has a margin of only 1% which means that here you can long two lots of GBP/USD as you need to put only $150 for each lot. Suppose that luck is not on your side and instead of going up the GBP/USD falls by 50 pips.. The consequences of this unfavorable move are clear: with broker A you lose $50 ($1 x 50 x 1 lot) but with broker B you lose $100 ($1 x 50 x 2 lots).
Introducing the concept of leverage, with broker B you have multiplied or leveraged your margin by 100 times whereas with broker A you have leveraged your margin by only 50 times.The main point that you should understand is that though Broker A requires you to put more money as margin you are in fact facing less risk than with Broker B.The above explanation has been the driving force behind the Commodities Futures Trading Commission (CFTC) proposal to decrease the leverage available in the forex spot market.
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 proposal was part of a larger regulatory overhaul of retail forex by the CFTC, enabled by authority granted to it in the Food, Conservation and Energy Act of 2008, or the Farm Bill. In effect a limit to leverage will clamp down on the potential of forex margin. This is because reducing leverage implies that the retail trader will have to put more money to trade the same amount currencies.
