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Forex Trading - Understand what Leverage mean.

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Leverage, financed with credit, such as that purchased on a margin account is very common in Forex. A margined account is a leverageable account in which Forex can be purchased for a combination of cash or collateral depending what your brokers will accept.

The loan (leverage) in the margined account is collateralized by your initial margin (deposit). If the value of the trade (position) drops sufficiently, the broker will ask you to either put in more cash, or sell a portion of your position or even close your position.

Margin rules may be regulated in some countries, but margin requirements and interest vary among broker/dealers, so always check with the company you are dealing with to ensure you understand their policy. Up until this point you are probably wondering how a small investor can trade such large amounts of money (positions).

The amount of leverage you use will depend on your broker and what you feel comfortable with. There was a time when it was difficult to find companies prepared to offer margined accounts at all, but nowadays you can get leverage from as high as 1% with some brokerages. This means you could control $100,000 with only $1000.
Understand what Leverage mean
Typically the broker will have a minimum account size also known as account margin or initial margin e.g. $10,000. Once you have deposited your money you will then be able to trade. The broker will also stipulate how much they require per position (lot) traded. In the example above for every $1,000 you have you can take a lot (contract) of $100,000. So if you have $5,000 they may allow you to trade up to $500,000 of forex.

That’s the theory, but in practice you need to have tradeable equity in your account. The minimum security (Margin) for each lot will very from broker to broker. In the example above the broker required a 1.0% margin. This means that for every $100,000 traded the broker wanted $1,000 as security on the position.

Variation Margin is also very important. Variation margin is the amount of profit or loss your account is showing on open positions. Let's say you have just deposited $10,000 with your broker. You take 5 lots of USD/JPY which is $500,000. To secure this the broker needs $5,000 (1.0%).

The trade goes bad and your losses equal $5,001, your broker may do a margin call. The reason he may do a margin call, is that even though you still have $4,999 in your account - the broker needs that as security and allowing you to use it could endanger yourself and him. Another way to look at it is this, if you have an account of $10,000 and you have a 1 lot ($100,000) position. That's $1,000 assuming a (1% margin) is no longer available for you to trade.

The money still belongs to you, but for the time you are margined, the broker needs that as security. Another point of note is that some brokers may require a higher margin at the weekeneds and overnight. This may take the form of 1% margin during the normal trading day and 2% margin overnight and 4% over the weekend.

Also in the example we have used a 1% margin. This is by no means standard. I have seen as high as 0.5% and many between 3%-5% margin. It all depends on your broker. There have been many discussions on the topic of margin and some argue that too much margin is dangerous. This is a point for the individual concerned.

The important thing to remember, as with all trading, is that you thoroughly understand your brokers policies on the subject and you are comfortable with and understand your risk.



1 comments:
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Mike.... said...
August 28, 2008 at 11:47 PM  

mampir balik bro..
makasi dah mau berkunjung ya..:)
btw gw ga ngerti masalah forex..jd binung mo komen apa..he..he..

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