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Understanding Margin
by forex.com
Trading currencies on margin lets you increase your buying
power. Here's a simplified example: If you have $2,000 cash in
a margin account that allows 100:1 leverage, you could
purchase up to $200,000 worth of currency-because you only
have to post 1% of the purchase price as collateral. Another
way of saying this is that you have $200,000 in buying power.
Benefits of Margin
With more buying power, you can increase your total return on
investment with less cash outlay. To be sure, trading on
margin magnifies your profits AND your losses.
Here's a hypothetical example that demonstrates the upside of
trading on margin:
With a US$5,000 balance in your margin account, you decide
that the US Dollar (USD) is undervalued against the Swiss
Franc (CHF).
To execute this strategy, you must buy Dollars (simultaneously
selling Francs), and then wait for the exchange rate to rise.
The current bid/ask price for USD/CHF is 1.2322/1.2327
(meaning you can buy $1 US for 1.2327 Swiss Francs or sell $1
US for 1.2322 francs)
Your available leverage is 100:1 or 1%. You execute the trade,
buying a one lot: buying 100,000 US dollars and selling
123,270 Swiss Francs.
At 100:1 leverage, your initial margin deposit for this trade
is $1,000. Your account balance is now $4000.
As you expected, USD/CHF rises to 1.2415/20. You can now sell
$1 US for 1.2415 Francs or buy $1 US for 1.2420 Francs. Since
you're long dollars (and are short francs), you must now sell
dollars and buy back the francs to realize any profit.
You close out the position, selling one lot (selling 100,000
US dollars and receiving 124,150 CHF) Since you originally
sold (paid) 123,270 CHF, your profit is 880 CHF.
To calculate your P&L in terms of US dollars, simply divide
880 by the current USD/CHF rate of 1.2415. Your profit on this
trade is $708.82
SUMMARY
Initial Investment: $1000
Profit: $708.82
Return on investment: 70.8%
If you had executed this trade without using leverage, your
return on investment would be less than 1%.
Managing a Margin Account
Trading on margin can be a profitable investment strategy, but
it's important that you take the time to understand the risks.
You should make sure you fully understand how your margin
account works. Be sure to read the margin agreement between
you and your clearing firm. Talk to your account
representative if you have any questions.
The positions in your account could be partially or totally
liquidated should the available margin in your account fall
below a predetermined threshold.
You may not receive a margin call before your positions are
liquidated.
You should monitor your margin balance on a regular basis and
utilize stop-loss orders on every open position to limit
downside risk.
You may click here for information on
managing margin in a forex.com account. |
