Retail traders are increasingly attracted to the Forex markets, because trading currencies has become increasingly accessible – available 24 hours a day, 5 days a week with potentially a low level of capital.
However, some concepts are still unclear to many new traders who wish to succeed in currency trading – even though a margin account may be opened, many traders aren’t able to provide a clear definition of margin trading, or leverage.
Yet both concepts are essential to fully understand how to profitably trade the foreign exchange market.
Let’s begin …
What is margin trading?
Unlike cash accounts, margin accounts allow you to use borrowed money to open and hold financial positions.
Margin trading allows you to obtain a greater exposure to the asset than you would if you used your capital to trade the asset for cash.
For each position you want to open, there is a margin requirement associated, which is the amount of money you need to put aside, as collateral, or security deposit with your broker.
Watch: All About Forex Trading using Margin:
Leverage is a by-product of margin
By only putting up a small percentage of a position as margin, it creates leverage or as some call it, gearing.
Key margin trading terms
There are some terms you’ll see in your trading platform that you need to know about, such as initial margin, maintenance margin, margin calls, and negative balance protection, among others.
Because this margin is only a small part of the full value of your position, this amount might not be enough to cover your losses if the market turns against you. You’ll then need to monitor your maintenance margin.
This occurs when the equity of your account falls below your broker’s margin requirements.
At that point, your broker may require a deposit of a certain amount of money in your trading account. If you don’t stump up the extra margin then the broker will close out your positions.
Many brokers offer negative balance protection – all EU regulated brokers must offer this as mandatory – which provides a safeguard to traders in times of higher volatility and trading volume, so retail traders don’t face a negative balance and owe more than they deposited.
Risks of margin trading
Borrowing money to trade in a volatile market is risky, as prices can change rapidly, and there is a possibility that the market moves against you, which will, in turn, increase your losses.
More than that, markets can move so quickly that it’s possible for you to lose more money than your initial deposit, as your balance can turn negative after margin calls.
Keep an eye on your broker’s policies about margin requirements and leverage, as depending on the currency, or the inherent economical or geopolitical risks, these policies can affect your trading.
Remember: Trading on margin amplifies your profits AND your losses , which means that you need to follow money and risk management rules to avoid wiping out your trading account.
So is margin trading good or bad
Well, margin trading is an incredible opportunity offered by brokers to trade large amounts of an asset in the financial markets with a small initial investment. Of course, this isn’t without any risks, but if managed well, you can amplify your profits while trading currencies.
For leverage to work in your favour as a trader you need to be profitable overall – if you are, leverage will enhance your profits, if you’re loss-making then leverage enhances losses. Taking the time to learn the skills needed to trade becomes even more important.
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