Forex Margin Trading: Earn Higher Profits With Less Borrowing Your Broker's Capital

Foreign exchange margin trading is a method of applying leverage to increase the purchasing power of your money. Leverage simply means using a small amount to control a much larger amount. This is feasible because it is not likely that the rate of a currency will fluctuate by more than a certain percentage points over a short time. So you can place a few hundred dollars in your brokerage account to trade on the margin - the amount that you think the rate could change. Your broker will practically provide you the difference.

Trading on margins is also known in equities and futures trading, but because of the special nature of currencies, you can get a much higher leverage in the currency markets. Depending on your broker's terms, you could be able to trade with 50, 100 or even 200 times your trading equity.

This may lead to big profits if you are successful, but it can also result in big losses if not. As a rule, the higher leverage you use, the riskier your trading is.

We can understand leverage and margins through an example.

Assume that the current rate on the British pound to US dollar forex market is shown as GBP/USD 1.7100. So to buy one British pound you would need $1.71. If you hoped for the value of the dollar to increase against the pound you may decide to sell enough pounds to buy $100,000. If your broker used lots of $10,000 each, this would be 10 lots. Then you would sit back and wait for the price to soar.

Several days later you might find that the rate had moved to GBP/USD 1.6600. Sure enough, the dollar has risen and the pound is now worth only $1.66. If you sell your dollars now and buy back into pounds, you will have garnered a profit of 2.9% less the spread. 2.9% of $100,000 is $2,900, so that would be an excellent trade.

But most of us do not have $100,000 spare cash that we want to trade on the currency exchange markets. So here is where the essence of margin trading comes into play.

Considering that you are buying and selling various currencies at the same time, your own capital simply has to cover any loss that you might make if the dollar falls instead of rising. And you would put a stop loss to limit that loss, so $1,000 might be all you needed to have in your account to make this $100,000 purchase. Your broker guarantees the other $99,000.

Actually most brokers now operate limited risk amounts where the system will automatically close out the position if whatever funds you have in your account are lost. This prevents margin calls which can be ruinous for a trader because they mean that you may lose more than you have. But with a forex limited risk account that is not a possibility. The broker's software that you use to control your account will not let you lose more than your account balance.

Using leverage in this way is so common in forex trading that you will soon do it without even thinking about it. Still it is important to bear in mind the risks. Lower leverage is invariably safer and you may never want to go to the highest degree forex margin that your broker would allow. You may also reduce your risk by using highly reliable forex signals. There are a lot of forex signal providers available online. But be aware of the fact, that not all forex signals are winners, so don't risk too much on any single trade.

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