How does margin trading in the forex market work?

A:

When an investor uses a margin account, he or she is essentially borrowing to increase the possible return on investment. Most often, investors use margin accounts when they want to invest in equities by using the leverage of borrowed money to control a larger position than the amount they'd otherwise by able to control with their own invested capital. These margin accounts are operated by the investor's broker and are settled daily in cash. But margin accounts are not limited to equities - they are also used by currency traders in the forex market.

Investors interested in trading in the forex markets must first sign up with either a regular broker or an online forex discount broker. Once an investor finds a proper broker, a margin account must be set up. A forex margin account is very similar to an equities margin account - the investor is taking a short-term loan from the broker. The loan is equal to the amount of leverage the investor is taking on.

Before the investor can place a trade, he or she must first deposit money into the margin account. The amount that needs to be deposited depends on the margin percentage that is agreed upon between the investor and the broker. For accounts that will be trading in 100,000 currency units or more, the margin percentage is usually either 1% or 2%. So, for an investor who wants to trade $100,000, a 1% margin would mean that $1,000 needs to be deposited into the account. The remaining 99% is provided by the broker. No interest is paid directly on this borrowed amount, but if the investor does not close his or her position before the delivery date, it will have to be rolled over, and interest may be charged depending on the investor's position (long or short) and the short-term interest rates of the underlying currencies.

In a margin account, the broker uses the $1,000 as security. If the investor's position worsens and his or her losses approach $1,000, the broker may initiate a margin call. When this occurs, the broker will usually instruct the investor to either deposit more money into the account or to close out the position to limit the risk to both parties.

To learn more, see Getting Started In Forex, A Primer On The Forex Market and Getting Started In Foreign Exchange Futures.

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