Margin Trading: Forex Isn’t only for Millionaires

We have discussed in full several large trades of $10,000. For many investors, this kind of money is out of reach, and for good reason—you don’t need this much money to trade forex! You just need to understand margin trading.

Currency traders employ what is known as “leverage” or “margin” to make trades on the foreign exchange market. If, for example, you choose to come into the market, you can make a trade with other people’s money—a forex broker’s money.

How Leverage and Margin Trading Works

In the foreign exchange market, leverage is the ability to buy more currency than what you have in your account. If, for example, you wanted to buy a position worth $10,000 US Dollars, then you could purchase this position for only $200 of your own cash. The broker would put up the other $9,800. This would be 50:1 leverage, since you need only put up $1 to buy $50 worth of currency.

Leverage is what makes foreign exchange trading so profitable. In buying a leveraged position, you can effectively control huge piles of currency without putting up a lot of money yourself. And even though you don’t put up a lot of money, you still get all the upside in the currency movements!

Let’s go back to our table to see how leverage affects currency trades:

In this example we purchased 5,000 GBP for $8,000 US Dollars. In reality, a trader would need only $160 to make this trade at 50:1 leverage, since their money is multiplied and matched by the forex broker.

To buy this position, you would choose to buy GBP/USD, and your account would be debited by $160 in cash balance. Upon closing the position, it would be credited with $700 (the profit from the change in currency pairs) plus your initial investment of $160. All in all, the above trade would net a $700 profit on a $160 investment, or a total return of 437% on an 8.75% change in currency values.

By now you’re starting to see why forex trading is so lucrative:

• Forex does not require a large investment
• You can grow your returns with leverage
• Small moves in currency prices make for big moves in profit and loss.

So now that we’re getting the basics under our belt, the next article will demonstrate how using leverage can make you money or cost you money.