Margin Trading - Understanding the Concept

Forex Market offers potentially profitable trading opportunities, created by the non-stop price fluctuations of different currencies that are being traded 24 hours-a-day all over the world in Foreign Exchange market. Currencies fluctuate. Their prices go up, their prices go down and their exchange rates keep changing continuously, due to various factors. Those up ward or down ward movements in currency prices keep generating trading opportunities, day in day out. The concept of Margin Trading is beneficial, if utilised wisely, especially, for individuals such as small investors, speculators, day traders etc. to participate in such trading opportunities available in Foreign Exchange market. The facility to trade on margin ensures that individuals with less risk capital are not deprived of participation in spot currency trading market.

How does it work? - Let us assume that the current exchange rate of EUR/USD is 1.3820-1.3825, a government report on employment situation in U.S. is about to be released today and you are expecting this report to be unfavourable for US Dollar. You plan to buy 100,000 Euro at current market price (1.3825) and sell Euro later at higher price to make profit if Euro does rise after report release, as anticipated.

Now, there are 2 scenarios:

• First - Buy 100,000 Euro at 1.3825 price in physical form if you have the required capital of USD 138'250 in hard cash which would be subjected to all market risks!!
  
  
• Second - Buy 100,000 Euro online, utilising up to 1% margin facility, through your online spot currency trading account. If you fund your account even with 5'000 US Dollars, your 1% margin capacity allows you to control a position of 500'000 US Dollars!!!

Let us further assume: The report is perceived "not good" for US Dollar by market participants and Euro starts hitting new highs within minutes. You sell 100,000 Euro at 1.3925 price. Difference in your buying and selling rate is 100 pips. Since each pip would be assigned a monetary value of 10 US Dollars for a 100,000 Euro lot. you make a cool profit of 1'000 US Dollars!

We now examine the First Scenario: Bought 100,000 Euro in physical form at 1.3825 and sold at 1.3925 levels = 1'000 USD profit made on a capital of 138'250 US Dollars. What is the rate of return? - Only 0.7234% !

Let us now understand the Second Scenario: Bought 100,000 Euro online using 1% margin facility through your online spot currency trading account. Bought at 1.3825 and sold at 1.3925 = 1'000 USD (same profit) but made on a trading capital of 1'382 US Dollars. (Margin calculation = 1% of 138,250 US Dollars - the required trading capital). What is the rate of return on risked capital ...72.35% !!! - This is the MARGIN TRADING!

Margin Money is NOT a Deposit. It is a "guarantee" money placed with your broker that provides financial protection against any loss in your account incurred by your forex trading transactions.

Margin Trading is risky but can also be rewarding. Financial implications must be examined, all aspects of margin trading must be researched through different resources to get a complete understanding and all risks must be evaluated very well.