What is Margin Trading?
Margin Trading is a powerful tool to allow you to gain exposure to price movements in forex markets without buying or selling physical currency.
A minimal margin (deposit of funds) may be used to initiate and maintain larger positions. For example, 1:400 leverage means you can control 400 times the amount of your margin deposit.
This is called “leverage,” and it’s the way forex traders can control large amounts of currency. It’s important to remember that high leverage is a double-edged sword that allows you to quickly earn profits while exposing you to fast and substantial losses.
What Are The Different Types Of Margin Trading?
There are several types of margins in Forex trading, and the trader’s deposit is known as a margin.
A broker needs this margin as a type of insurance so that the trader’s open position(s) is secure.
The amount of margin required varies among forex brokers and, of course, depends on the amount of leverage needed.
With multiple trading positions, multiple margins are needed which are then combined to create a large margin deposit and use it to secure trades.
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Forex margins are defined through percentages ranging from 1% to 25%. Using the broker defined percentages a forex trader will then be able to calculate the leverage that could be used within their trading account.
For example, a 2% margin requirement equates to a leverage of 50:1.
What Is Account Margin?
Account Margin is the funds a trader has in his trading account. In the above picture, it is the “Balance”.
In this margin account, a trader is investing with his broker and during leverage, he is risking both gains and losses.
What Is Free Margin?
Free Margin is the funds that accessible in the trader’s account for opening new positions. Free margin is also called “Usable Margin” in some resources.
When Does Margin Call Occur?
Margin Call occurs when losing trade positions decrease below useable margin levels. A margin call means that the broker will close all or several open positions at the market price.
What Is Used Margin?
When a trader obtains a margin call/closes a position the fx broker is obliged to give back the money they ‘locked in’ to ensure that the current position remained open. “Used Margin” is the amount of that was reserved. Used margin is referred to as “Margin” in the above image.
The Golden Rules of Margin Trading
#1 Understand the interest rates
Except for a swap-free (no interest) account, there is usually a rate charge on what is borrowed if the trade is left open overnight. For stock trading, a broker usually pays about 8 percent annual interest on borrowed funds.
You need to know the interest rates on your account (if applicable), otherwise, any gains you make can be swallowed up by interest charges.
#2 Learn the broker’s rules
Make sure you read the broker instructions carefully before making the first marginal transaction. Seemingly fantastic forex accounts with special offer promotions can include unnecessary charges.
#3 Use stop-loss orders
Stop-loss orders can prevent margin calls from occurring and also save you from a bad loss. When trading with large margins you are exposed to great upsides and great downsides so a stop-loss order is a damage limitation mechanism.
#4 Margin calls are bad
A margin call occurs when a trade goes against you and you and it requires you to either deposit more funds into your account to offset the losses on margin or sell a position completely.
As an investor, this is a bad position to be in so you should fully understand your margin and implement safety mechanisms to safeguard your finances.
#5 Keep An Eye On The News
Any position held on margined funds is vulnerable to economic and political changes. Special attention should be paid to upcoming news particularly budgets and earnings reports.
Some investors may buy stock on the margin because they anticipate positive news but they should be prepared in case it does not go their way.
#6 Don’t risk everything
Keep some cash as backup funding, to purchase another position or to recover from a margin call. One of the worst things you can do is put all your money into one trade because you can be instantly wiped out.
Hedging your finances is more likely to earn you a profit overall even if you do not win all your trades.
#7 Don’t over speculate
The old adage “speculate to accumulate” is true to some extent, but over-speculating is never a wise thing to do, particularly not oppressed.
Furthermore, forex trading’s golden rule: Never use the money you can’t afford to lose.”
There is an art to margin trading and it all comes back to risk management and understanding the markets.
Many new traders become overenthusiastic about the possibilities of leverage because they have the opportunity to turn their low deposits into something 400 times + greater.
What they do not grasp is that leverage is a double edge sword as is margin if your trade is going against you.
If you are highly leveraged then a turning trade will pull you down to a margin call so fast that you may not even have time to assess and manage the situation.
In forex trading, you should carefully formulate a strategy that should incorporate your margin, leverage, the market you are trading, and your actual budget.
You should never enter a trade or deposit money that you can not afford to lose in the hope that it will instantly treble in size because this is rarely the case.
Finally, you should fully understand the margin terms that your broker is stipulating before you open an account with them.
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