It is quite easy to misunderstand the concept of Margins in Forex as it is relatively new to the market. Simply put, margin is the minimum amount of money that is required to place a leveraged trade and can be a very useful risk management tool.
The Concept of Forex Margin
A Forex Margin is simply an act of extending credit for the sole purpose of trading. It is a good faith deposit that a trade places as collateral to begin a trade. In Forex trading, using margins to trade refers to trading on funds borrowed from your broker in order to increase your exposure in the market. To open a margin trade, your broker needs to lend you a certain amount of money which depends on the ratio of leverage used, then apportions a part of your trading account as collateral or in this case, margin for that trade. Whatever is left off as the balance in your account can then be used as a shield from negative fluctuations from existing leveraged positions or to open new leveraged trades. They can also be referred to as your free margin.
Advantages of Margin Trade
It is advantageous to trade on margins because you are liable to make a high percentage of profit compared to your account balance. For instance, if you have a $5,000 account balance and you are not trading on margin, then you initiate a $5,000 trade that gives you a net of 500 pips. Remember, each pip is worth 50 cents in a $5,000 trade. Therefore, the profit from your trade would be $250 or a 5% gain. Whereas, if you were to make use of the same amount to make a 50 to 1 margin trade, you’ll be getting a trade value of $250,000, the same 500 pips would amount to $2,500 or a 50% gain.
Disadvantages of Margin Trade
A seemingly disadvantage in using margin to trade is simply the risk involved. Considering the example we made above, let’s make an opposite assumption. Still using a $5,000 account balance to trade, you lose 500 pips. Your loss is only at 5% or $250. This is not bad as you’ll still have more funds to trade with. Now, if you were to make a 50 to 1 margin trade for $250,000, a loss of 500 pips takes $2500 or 50% of your capital. Another chance at that kind of trade, and you’d have an empty account but if you were to stick to the original 5% or $250 loss, you’d still have to try like about 19 times more before you exhaust your funds.
Furthermore, on Margins, we’d be explaining the relationship between Leverage and Margin in Forex trading. Fxcryptonews.com is all about breaking the rocks into granular nodes and bringing to you news, events and updates on everything crypto and forex.