What is Margin: Margin in Forex is similar to margin in stocks or commodities. Margin or leverage is the minimum security amount required by broker to provide you a loan to trade a larger lot. Margin is calculated in percentages. Brokers provide margin ranging from 5-0.25% means leverages ranging from 20:1 to 400:1. Trading on a margin means that you can trade a much larger lot with a smaller investment. It means you can trade a lot of up to $40,000 with just an investment of $100.
Margin has its benefits. Let’s be practical; not everyone has the funds to trade currencies in 1:1 leverage. Margin gives you the opportunity to earn much larger ratio of profit with less amount of investment. This increases the investment to return ratio giving you a tactical advantage.
Investing – Two Ways:
1. You didn’t use margin and invested in 1:1 leverage. This means you bought a lot of 1000$ for 1000$. Suppose after a day’s trading your lot rises to 1001$. This means after a day of you investing your funds you earned 1$.
2. Now we open the same trade with leverage. Suppose we use a standard medium risk 100:1 leverage. Now to purchase $1000 lot we will require just $10, so we can purchase 100 lots of $1000. So if the lot rises to $1001, we will earn 100$. That’s a whopping 10% return on your investment in a single day.
Everything has a disadvantage or some shortcomings. Even excess protein leads to gout. Leverage may be looking good after seeing $100 gain in the above example, but you may also lose that much if the lot falls to $999. So you might have calculated that if it falls to $990 you will wipe out your entire account. Now some newbies may be thinking that forex is calculated in pips why am I explaining it in lots of $1000. Well $1000 is the standard lot size. It’s simple, if you are trading in 100:1 leverage it means 100 pips = amount invested. If the pair gains 100 pips you doubled your investment and if it loses 100 pips you have lost the investment. If it is 50:1 leverage 200 pips = amount invested. Keep in mind, just because your broker offers a certain level of leverage doesn’t mean that you have to use the full amount of leverage on each trading position.
Well if you are seeing this then you are in trouble. This call is received when the equity in your account cannot cover your losses on the open positions. If the equity falls below your used margin, then the broker will close all or some of your open positions. In simpler terms once you open a position you lock in some of your equity and cannot touch it or use it. If the positions open are in negative and the equity or balance in your account is below your used equity than it is time for margin call.
The higher the leverage used, the more risky it is. It is a double edged sword and can go either way.