Saturday, January 4, 2014
But what exactly is leverage and its counterpart, margin, and what do they matter to forex traders? Furthermore, can these be worked more effectively to the trader’s advantage, and what should you bear in mind to get the most out of these features of trading forex online?
What Is Margin and Leverage?
Leverage: As we’ve previously touched upon, leverage allows ordinary transaction sizes to artificially feel much bigger. Leverage is essential borrowed funds, lent by the broker, which enables traders to take much bigger positions in currency markets than would otherwise be the case. Consider the following example of a market that moves up 1% over the period of an investment.
At a £100 investment in a non-leveraged trade, the trader would realize a gain of £1 – at 1% of the £100 stakes. Assuming a leverage of 100:1 (which is relatively modest in the world of forex trading), the same £100 position would be worth £10,000, with £9,900 being supplied towards the transaction by the broker. The same 1% is then worth £100, with a total position value of £10,100 – when the position is closed and the broker automatically repaid, leverage has allowed for this trader to double their money.
It is hopefully obvious from this albeit simplified example just how powerful leverage can be. However, it can be equally as strong on the profit as on the loss side, so traders need to be careful not to start accruing unlimited debts for trades that go astray.
Margin: In order to fund the leverage part of the transaction, brokers need some security from the trader, presented in the form of margin – a deposit amount against the total transaction size. In some instances, this will be expressed as a percentage of the transaction that traders will be required to fund out of their available capital. If the position falls, the margin percentage will be eroded and may be requested to be topped up by the broker at any time – known as a margin call. Margin calls can be one of the most dangerous occurrences for a forex trader, and so it pays to structure your trading in such a way that you can always afford to fund margin requirements if a position starts to lose ground.
At a £100 investment in a non-leveraged trade, the trader would realize a gain of £1 – at 1% of the £100 stakes. Assuming a leverage of 100:1 (which is relatively modest in the world of forex trading), the same £100 position would be worth £10,000, with £9,900 being supplied towards the transaction by the broker. The same 1% is then worth £100, with a total position value of £10,100 – when the position is closed and the broker automatically repaid, leverage has allowed for this trader to double their money.
It is hopefully obvious from this albeit simplified example just how powerful leverage can be. However, it can be equally as strong on the profit as on the loss side, so traders need to be careful not to start accruing unlimited debts for trades that go astray.
Margin: In order to fund the leverage part of the transaction, brokers need some security from the trader, presented in the form of margin – a deposit amount against the total transaction size. In some instances, this will be expressed as a percentage of the transaction that traders will be required to fund out of their available capital. If the position falls, the margin percentage will be eroded and may be requested to be topped up by the broker at any time – known as a margin call. Margin calls can be one of the most dangerous occurrences for a forex trader, and so it pays to structure your trading in such a way that you can always afford to fund margin requirements if a position starts to lose ground.
