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Forex margin trading is a way of applying leverage to increase the purchasing power of your money. Leverage simply means using a small sum to control a much larger sum. This is possible because it is unlikely that the value of a currency will change by more than a certain percentage over a short time. It works by funding your trading account with enough to trade on the margin, which is the amount a currency is likely to fall. The balance is, in effect, lent to you by the broker. It is a technique that the makers of trading robots, like the Forex Megadroid Robot, have attempted to build into their systems.
Trading on margins is also known in stock and futures trading, but because of the special nature of currencies, you can get a lot more leverage in the forex market. Depending on your broker’s terms, you may be able to control 50, 100 or even 200 times your account balance.
This can lead to big profits if you are successful, but it can also mean big losses if not. In general, the more leverage you use, the more risky your trading is.
We can understand leverage and margins if we consider an example.
Imagine that the current rate on the British pound to US dollar forex market is shown as GBP/USD 1.5100. So to buy one British pound you would need $1.51. If you expected the value of the dollar to rise against the pound you might decide to sell enough pounds to buy $100,000. Many brokers us lots of $10,000, making this trade 10 lots. Then you would sit back and wait for the price to go up.
After a few days you see the price is now GBP/USD 1.4600. Just as you expected, the dollar increased in value making the pound now worth just $1.46. If you decide to sell your dollars now and buy pounds, you will have made a profit of 3.3% less the spread. 3.3% of $100,000 is $3,300, so that would be an excellent trade.
But most of us do not have $100,000 spare cash that we want to trade on the currency exchange market. So here is where the principle of forex margins comes into play.
Because you will be trading in several different currencies at any time, the money you need in your account only has to be enough to cover any potential loss. You would be able to place a stop loss on your trades to limit losses, and so a balance of $1,000 could potentially be enough to make $100,000 trades. Your broker guarantees the other $99,000.
Recently brokers have started to offer limited risk account, where your trades are automatically shut down if your account balance hits zero. This prevents margin calls which can be disastrous for a trader because they mean that you can lose more than you have. The broker’s software that you use to control your account will not let you lose more than your account balance.
Using leverage in this way is so common in currency trading that you will soon do it without even thinking about it. However, you should always be mindful of the risks. Lower leverage is always safer and you may never want to go to the maximum forex margin that your broker would allow. Some people do prefer to use automated systems to manage this type of trading for them, you can download Forex Megadroid yourself and test it on a demo account first.
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