Getting good at online fx trading means knowing several key concepts of successful forex trading – and how you can implement these concepts in your own trading strategy. Two major concepts every individual trader needs to know, understand, and use are the concepts of margin and leverage.
By using margin and leverage, you can control large amounts of currency far beyond the amount of capital you have invested in your account – thus giving you the same potential to make money as the big boys in the business.
As you’ll see, margin and leverage are vital and essential in making money with global forex trading.
What is Margin?
Margin is a trading term that basically means borrowing money to trade. If you have $1,000 in your account, you can purchase $1,000 worth of currency. But, if you buy on margin, you can essentially borrow money from your broker and purchase, say, $5,000 worth of currency.
Buying on margin gives you the potential to make far more profit than you would normally be able to, which means you do not have to have nearly as much invested to get started. Of course, there is a downside: If your investment goes sour, you can lose not only the money you have of your own, but also the money you were loaned. And that money must be paid back in what is known as a ‘margin call’.
So, buying on margin can be risky, but it can also be a way you can increase your profits and actually make money with currency market trading – especially with the small profit margins inherent to the industry.
What is Leverage?
Leverage is closely related to margin and defines how much capital you can control with your initial investment. The amount of leverage – or control – is generally referred to by ratios. For example, a 50:1 leverage ratio is common. This means that for every dollar you have in your account, you can control 50 dollars of currency.
Let’s take a look at leverage and how it works.
Let’s say you have $1,000 in your account. You open a margin account that gives you a leverage ratio of 50:1 (or 2% margin). Let’s also say that EUR/USD is selling at 1.500.
With your original $1,000, you can purchase 667 units. If you use leverage, though, you have $50,000 at your disposal, and can purchase 33,334 units.
Without leverage, your profit, if EUR/USD moves up by 10 pips, is $6.67. With leverage, your profit is 50 times larger, or $333.50. That is a profit of approximately 33% on your original investment.
High leverage is made possible because currencies rarely fluctuate more than 1% in a given day. This is why leverage is much higher with forex than it is with equities or futures.
If you are an individual investor, you need to learn about and possibly take advantage of margin and leverage. Leverage and margin are incredible opportunities to make considerable profit. They do come with risk – if your trade above was to drop by 10 pips, you would lose $333.50 – but once you become proficient at forex trading, you’ll realize that using leverage is the main way to make a significant profit with your trades.