Leverage and Margin

When it comes to learning forex trading, one of the most important concepts is that of leverage and margin. In order for a trader to increase the amount of profits made on trades, they must be able to apply leverage and margin. While leverage can get a trader into some trouble if not used properly, most traders are able to learn the concept rather quickly and begin using it to their advantage.

Leverage and margin are very similar in nature, with each approaching the trade from different angles. Leverage refers to a trader opening a position and putting down a fraction of the position's value in good faith. The amount they are required to put down is called the margin requirement, also referred to as a good faith deposit. When a trader closes out the position, they usually get back all of this amount. The only time this may not happen is in the event of a margin call, which is something no trader wants to see happen to their account. When this occurs, it means the account does not have enough equity to meet the margin requirements for the current positions that are open. If this is the case, all open positions within the account are immediately closed at the current market rates.

Margin calls are the one thing no trader wants to see happen to their account, but there is a silver lining to it. Even if an account falls into negative territory and is left with a negative equity balance, the account will be automatically reset to zero. While the trader will have lost some money, they will have learned a valuable lesson and not have to worry about losing any more money that the amount of their original deposit.

One big advantage the forex market offers its traders is that it provides some of the lowest margin requirements of tradable financial instruments. This allows a forex trader to have much more purchasing power than an equity or bond trading account of similar size. One thing traders should remember is their profit or loss will be based on the position size, not the margin requirement. Leverage is often described as the ultimate double-edged sword, in that it increases profits as positions move in one's favor or losses as they move the opposite direction.

Most traders are careful to not overleverage their accounts by putting too much of its value at risk or opening more positions than the account can handle. Just how much leverage used is up to each trader. Short-term traders use more leverage because their positions are not open very long, while long-term traders use less leverage to ensure minor changes in value do not adversely affect their accounts. The general rule is just because a trader has access to much leverage doesn't mean they should always use it. By trying different strategies and setting realistic goals, it's possible to use the concept of leverage and margin to one's advantage and make many profitable deals.