Forex Margin is the key which has unlocked the opportunity for retail traders to profit from changes in currency prices. In the last decade the forex market has become accessible to anyone who has a few hundred dollars.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, a large majority of traders lose because they do not understand how this key concept works.
Forex Margin is defined as the sum of money that someone has to put with a forex broker to be allowed to trade a currency pair. So if you have the intention to trade $100,000 worth of currencies your forex broker will request a margin of $1000.Put in a techical way your trading capital has been leveraged by 100 times
Generally the online forex brokers will display their quotes for a currency pair in the following way:GBP/USD.As an example let us suppose that the GBP/USD is currently trading at 1.5000. This means that with one pound you will get 1.5000 US Dollars. So if you want to buy 10,000 pounds at the current market price of 1.5000 you will have to sell 15,000 US Dollars. And your forex margin in this case will be only $150. I hope that you can now see how with only a fraction of $150 you can trade up to $15,000 worth of currencies
Let us now dig a little deeper to uncover the dangers of forex margin
In the hypothetical example which follows we will make a few assumptions. First there are two forex brokers namely A and B and their margin requirements are not the same. For broker A it is 2% whereas for broker B it is 1%. Second we assume that with each of these two brokers you have $ 5,000. Third the price of the GBP/USD is trading at 1.5000 such that a one pip move of 0.0001 is worth one dollar. Finally you will be willing to put $ 300 as margin on each trade.
Therefore with broker A to buy one mini lot of the GBP/USD you will need to put $300 (2% x 15000) as margin.. On the other hand, Broker B has a lower margin requirement of 1% and thus you will be able to buy 2 lots because here you need to put only $150 as margin for one lot. Now let’s say that the trade is a bad one, and the GBP/USD moves 50 pips in the wrong direction. With broker A you lose $50 ($1 x 50 pips x 1 lot) but with broker B you lose $100 ($1 x 50 pips x 2 lots)..
So with broker A you have leveraged your account by 50 times but with broker B you have leveraged your account by 100 times.The most important point that you must grasp here is that with Broker A less risks are involved because you have leveraged your account by only 50 times..The above explanation has been the driving force behind the Commodities Futures Trading Commission (CFTC) decision to decrease the leverage available in the forex spot market.
In August 2010 the CFTC has decided to reduce Forex Margin in retail forex customer accounts to 50-1.The proposition by the CFTC for more regulations on Forex Brokers comes from the authority granted to it by US law makers in 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.
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