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.

RELATED FAQS

  1. What's the difference between the coverage ratio and the levered free cash flow to ...

    Learn the differences between the equity evaluation metric, the levered free cash flow to enterprise value ratio and various ...
  2. How do I learn technical skills for trading commodities?

    Learn what resources are available to learn about trading commodities, and understand some of the differences between stocks ...
  3. What are the different sources of business risk?

    Explore the various sources of business risk for companies and learn how critical risk management is to a company's financial ...
  4. How does DuPont Analysis measure financial leverage?

    Learn about how DuPont analysis measures financial leverage using the equity multiplier, and see when the equity multiplier ...
RELATED TERMS
  1. Exchange Traded Derivative

    A financial instrument whose value is based on the value of another ...
  2. Open Trade Equity (OTE)

    Open trade equity (OTE) is the equity in an open futures contract.
  3. Leverage Ratio

    Any ratio used to calculate the financial leverage of a company ...
  4. Ceded Reinsurance Leverage

    The ratio of ceded insurance balances to policyholders’ surplus. ...
  5. Forex Spread Betting

    A category of spread betting that involves taking a bet on the ...
  6. ICE LIBOR

    See LIBOR

You May Also Like

Related Articles
  1. Mutual Funds & ETFs

    Invest in Emerging Market Currencies ...

  2. Mutual Funds & ETFs

    The Top 3 Silver ETFs

  3. Active Trading Fundamentals

    Invest In Gold Through ETFs

  4. Brokers

    Private Equity's Returns Are Tempered ...

  5. Economics

    Who Benefits From South Korea's Lowered ...

Trading Center