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Monday, August 6, 2012

Forex Margin & Margin Call

While Forex brokers allow traders to trade money ten times more than what's been actually invested, brokers always know that traders never lose money beyond their real investments. The warranty here is Margin.

Margin in Forex identifies a requirement for the trading account to have certain amount of real funds on balance as a collateral to cover any possible losses.

In other words, a margin prevents traders from losing virtual money (the money they don't have).
Margin makes sure that while having trading positions open, traders have just enough real money on balance to cover losses if they are to occur. 

Margin requirements vary from broker to broker and depend on the leverage being offered.

Example: Leverage — Margin table

LeverageMargin requirement
20:1 5%
50:1 2%
100:1 1%
200:1 0.5%

So, at 20:1 leverage a trader required to have 5% of the value of each open position in the account intact. This equals to $500 on hold per each lot of 10 000 units. ($10 000 * 5% = $500)

Available margin, Free margin, Usable margin — all are the synonyms used by different Forex brokers — the margin that regulates the allowance for your trading appetite:

A trader can not open a trading position which exceeds his Available margin; and/or keep an old position running if the Available margin is completely drained out, e.g. equals 0.

In case a trader uses the entire Available margin he will no longer be able to open new trades, and should monitor carefully any open trading position that is currently at loss. If the losses continue to accumulate further, there is an immediate risk to get a margin call.

Available margin = 0

Maintenance margin, Required margin, Used margin — also are synonyms, which suggest funds that are in use, currently locked in order to maintain currently open trades.

In other words, a Margin call occurs when due to losses trader's Account Equity (balance + the sum of all floating profit/losses) becomes equal to the Used margin and/or slips a fraction beyond it.

Account Equity <= Used Margin

Margin call simply means that all or a certain part of open trades will be closed in order to prevent further losses beyond the real account balance.

No trader ever wants to receive a margin call and have his/her running trades closed despite own will.
That's why traders try monitoring their account parameters as they trade.  

When a Margin call situation seems to be inevitable, a trader may try to prevent it by either adding more funds to the account, or closing few losing trades at own choice, or change the account leverage to a higher one (with higher leverage Margin requirements will be lowered, but in each case it's a temporary solution to a trouble that has to be solved — a losing trade(s) must be taken care of in a timely manner).

Remember we said earlier that the higher the leverage, the lower the margin? And the lower the margin, the less money is required to keep open trades running safe?

Let's look at the next trading conditions offered by a Forex broker:

Leverage20:130:140:150:1100:1200:1
Margin Required5%3.3%2.5%2%1%0.5%


If a trader takes the highest leverage of 200:1 the margin is going to be only 0.5%. As a smart trader with a sound knowledge of money management he will never trade inadequately large lots, thus leverage won't hurt him, but he will  benefit from a lower margin requirement by dropping yet another worry of getting a margin call.

That's it. Now you know how to deal with the leverage and margin in Forex:

Take any leverage at your choice and taste, but don't overuse your leverage powers; instead trade lots sizes which in your opinion are appropriate for your account size and your own risk appetite.
Take advantage of a lower margin by increasing your leverage.

There is a final but very important fact every trader should memorize:

If you are ever going to step away from the charts and leave trades open without placing protective stops, take the lowest leverage possible or don't take any at all.

Without a stop order in place the risks of losing an entire account balance or its large part increase dramatically. The consequences of some large economic events may shift prices in Forex market by 500 pips and more in a fairly short  period of time. The chances are, your account won't be prepared to sustain such dramatic shifts and money will be lost. In such cases the only hope to save some capital comes from nowhere else but a margin call...

That is why trading without stops in Forex means being not serious about long prospective of own investment.

Good luck to you all!

Friday, August 3, 2012

Leverage in Forex

Leverage in Forex allows increasing the power of trading accounts by literally allowing traders to operate larger funds. For each real dollar funded by a trader, Forex brokers offer a leverage up to 400:1 or even higher, which increases traders buying/selling capabilities while trading Forex.

A leverage of 200:1, for example, means that for each dollar invested a broker adds $200 dollars on top, making the trading account 200 times larger. Thus, funding your account with $1000 at 200:1 leverage would enable you to operate a  $200 000 account.

Only traders with really large accounts may afford trading Forex without leverage. For all other traders leveraging their investments is often the only way to participate in Forex currency trading and be able to operate large trading lots while  make reasonable profits from trading Forex.

What leverage does, it allows a trader to trade money he/she doesn't possess. We may call it virtual money trading.

While it is possible to make profits with virtual money in Forex, it is absolutely impossible to lose virtual money, instead traders lose only real money they have invested or earned as a result of profitable trading.

Forex brokers offer various leverage options: from 10:1 up to 500:1 Forex leverage know today.

While experienced traders have no problems choosing the next best leverage for their new trading accounts, novice traders often have difficulties selecting the right leveraging option. Besides that, warnings about dangers of high leverages published online by Forex traders create additional fears.

There is danger in almost everything if one doesn't know how to use it.

High leverage can be dangerous IF a trader doesn't have the basic knowledge about using it properly. That's right, a basic knowledge about leverage is just enough to keep any Forex trader away from troubles and actually stop worrying about  this subject at all.

Let's learn those basics:
  • Leverage enables any trader to be an equal participant on the Forex market alongside with large institutional traders, such as banks, various financial institutions and individuals with large trading accounts;
  • Leverage allows trading larger positions, e.g. operate larger funds;
  • The higher the leverage the higher trader's buying/selling capability at any moment;
  • The higher the leverage the lower the margin requirements
"What leverage does, it allows a trader to trade money he/she doesn't possess. We may call it virtual money trading. "

and

"While making profits with virtual money is possible, it is absolutely impossible to lose virtual money, instead traders lose only real money they have invested or earned as a result of profitable trading."

Let's take an example.
Invested capital = $1000 USD.
Leverage 200:1
Buying/selling capability = $1000 * 200 = $200 000

This enables a trader to buy/sell a regular trading lot size of 100 000 units, which looks good and feels good (when thinking about potential profits). But is it safe?

Leverage allows to trade larger positions in the market. Larger positions mean larger profits when a trader wins a trade, but also larger losses if a trader was wrong about the market direction. In our case (with 100 000 units lot size) each pip a trader earns brings him $10 profit, but each pip he loses cost him -$10.

What concerns us is the Loss question. So let's focus on the simple math.
A normal situation: the market moves -20 pips against our trader.
20 pips * $10 = -$200 USD

Those $200 dollars will be subtracted from initial $1000 account balance, which will bring it down to $800. (Buying/selling capability will now match $800 * 200 = $160 000)

What we actually have is that 1/5 of the trader's initial investment has been lost in a single trade(!) — a trade where conditions were moderate, e.g. losing 20 pips is not a big deal in currency trading; traders on average lose 35-50 pips on each trade. No need to mention that in two consecutive losing trades of -50 pips each, our trader would lose his/her entire account, it is so quick!
  • 50pips * $10 = -$500
  • $500 * 2 times = -$1000
That's why you hear traders calling a high leverage "Leverage the killer".

The conclusion is: one cannot trade with large virtual money having invested little real money. A highly leveraged account and a high buying/selling capability doesn't mean one should be trading away with large trading lots.

In our case, having invested $1000 USD no matter at what leverage, a trader can only trade reasonably with a lot size of 10 000 units (or less) where each pip would cost $1 (or less). Hence, losing 20 pips would mean losing only $20 on one trade. 

We advise trading with a pip value smaller or equal to $1 for accounts smaller than $1000 USD.
(1 pip on average equals $1 when trader open 1 lot of 10 000 units)

If we cannot use our buying/selling capability provided by a leveraged account, how can we use leverage then? What difference would it make if we take lower or higher leverage?

We need a higher leverage to have a lower margin.

Stay tuned for margin in forex.


Cheers!