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by John Eather

Margin is one of the key features that makes foreign exchange trading so exciting a prospect. Without a factor like margin, trading in this area would be completely out of reach for the ordinary man in the street who wants to invest in this area. However, what exactly does “Margin” mean?

Margin allows traders in forex to leverage by controlling a large amount of currency with a proportionately small amount, or what is called a deposit. Essentially a margin account has to be opened through a foreign exchange broker and the trader is then able to control currency lots. Currency lots vary in size but they generally are around $100 000.

The leverage the trader gains from the margin account is expressed as a ratio. For instance a leverage ratio of 100:1 means the trader is able to have access to control over 100 x their deposit amount of forex assets. So essentially in a $100 000 standard forex lot with a 1% margin will require a deposit of $1000.

It has to be borne in mind however that trading on margin can increase losses as well as profits. The potential is there, and is very real for any trader, to lose as much as if not more than their original deposit. It is possible to put safeguards in place to prevent this from happening. In order to limit any losses a broker generally terminates a transaction which goes beyond the deposit in the margin. However losses do occur when even a small change in a currency occurs, as do profits.

Forex is actually traded in smaller units than cash is. For example the US dollar trades down to four decimal points. For instance instead of $1.42, it will ready as $1.4238. The smallest unit is known as a “pip”. When trading US dollars in a value of a $100 000 lot, your pip is valued at $10. If the price of the dollar were to change from $1.4238 to 1.5238, it is a 100 pip difference and while this loss or profit of $10 may be meaningful to a tourist, it means very little to an investor. This example indicates how margin is able to increase potential profit or loss.

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