Forex Margin and Leverage
Margin and leverage are among the most important concepts to understand when trading forex. These essential tools allow forex traders to control trading positions that are significantly larger in size than would be the case without these tools being used. At the most basic level, margin is the amount of money required to open and retain a leveraged trading role in a trader’s account as a deposit.
What is a leverage trading position?
Leverage simply allows investors to manage bigger positions with a limited amount of actual trading funds. In the case of 50:1 leverage (or 2% per cent margin required), for example, $1 in a trading account can control a position worth $50. As a result, leveraged trading can be a “double-edged sword” in that both potential profits, as well as potential losses, are magnified according to the degree of leverage used.
To illustrate further, let’s look at a typical USD/CAD (US dollar against the Canadian dollar) trade. To buy or sell a 100,000 of USD / CAD without leverage would require the trader to put up $100,000 in account funds, the full value of the position. But with 50:1 leverage (or 2% per cent margin required) to open and maintain that $100,000 USD/CAD position.
While the trader is expected to open this trade with a margin sum of only 1/50th of the actual trade volume, any profit or loss on the transaction will equate to the full amount of $100,000 leveraged. This would be a gain or loss of about $10 per one-pip change in value in the case of USD / CAD at the current market price. It shows the distortion of profit and loss when using margin to exploit trading positions.