FXLORDS Increase Your Profits
When trading Forex, one of the key elements that a trader needs to understand is the relationship between leverage, margin and margin calls.
It has been cited that the main reason that novice traders lose money is that they don’t understand the principles of leverage or don’t consider the downside of what leverage can offer.
If you decide to trade Forex, the movements in the value of currency pairs is often so small that simply by buying using a portion of your capital you would see only minimal gains (or minimal losses), meaning that it would be almost pointless trading.
In the past it was only the big players like banks or investment houses that had the money to make trading worthwhile but since the advent of leverage, your everyday trader can trade like a bank if they wish.
To do this Forex Brokers effectively provide the multiples based on the amount the trader decides to trade with from his trading account. It’s not a monetary transaction so there is not interest on the borrowing; the Forex Broker simply provide this risk in exchange of the spread, which is practically his return. The amount the broker provides depends on the leverage ratio offered to them by Liquidity Providers. Leverage ratios are higher outside of the US as US regulatory authorities were concerned over reckless trading and placed limits on leveraging which is a maximum of 1:50 whereas outside of the US, leverage ratios of 1:700 are not uncommon. Usually Leverage ratios falls between 1:100 – 1:400.
In practice this means that a trader with a capital of $10,000 could effectively place a trade of $4m assuming a leverage ration of 1:400. The benefits of this are that a 1% gain in the currency pair would lead to a $100 profit if the trader could only work on a 1:1 ratio but with his leverage ratio of 1:400, the profit would be 1% of $4m – $40,000, which is an effective gain of 400% on his capital.
Margins are effectively leverage by another name and in another form. For example, 1:50 leverage is a margin of 2%, a 1:200 leverage ratio is 0.5% as a margin and so on. A quick way to calculate it is that multiplying the larger number in the ratio by the margin should equal 100. for example…
1:40 leverage = 2.5% margin as 40 x 2.5 = 100
Many emotional traders simply look at the potential upside of leveraging when they should first consider the downside. If that 1% rise was reversed into a 1% fall, then effectively the trader has lost four times his initial capital or, looking at it another way, he would only have had to see a 0.25% fall – very common in Forex trading, to have wiped out his capital. Obviously the sensible trader would trade less of an amount (smaller position) or would have set a stop loss to put a cap on his losses. Forex brokers also do the same, but it’s known as a margin call. So, in other words, when a trader execute a position in the currencies market, the Broker carries the risk by taking the same exact trade. So when there’s no enough funds available to hold this trade for more time due to the floating loss incurred on the trading account, The Forex Broker has to Stop his Loss, and notify the client on a Margin Call. Usually, regulated brokers are required to inform the trader when opening the trading account their Margin Requirement, Margin Call Level and Leverage. Sometimes this information will be set as a specific amount of dollars (say 100 US Dollars) and then I would be the trader’s job to keep an eye on the margin. If the trade falls close to or hits the margin, then the broker will automatically close the trade to minimize risk they are exposed to because of the client’s Trading position.. Better brokers will telephone or send an SMS to tell traders that their trade is approaching a call, giving them the option to close the trade or add more capital to support it.
Sensible traders use only a small proportion of that capital on each trade – often less than 5%. In this way they can benefit from leverage but also reduce losses and the likelihood of margin calls. It’s also recommended that you don’t seek out high leverage ratios – part of the reason why novice traders should use micro accounts where often the leverage ratio is around 1:50.
One of conclusions a trader forms about Forex trading and on regulations after a few years of experience, that a lot of small traders lose money in Forex trading unfortunately because they didn’t understand what they were doing, and what does Margin requirements, Margin Call Level and Leverage mean, which is something we at FXLORDS are working hard to help them overcome.
