In the Forex market, it’s important to understand both the benefits, and risks, of trading with leverage. Leverage is expressed as a ratio and is based on the margin requirements imposed by your broker. For example, if your broker requires you to maintain a minimum 2% margin in your account, this means that you must have at least 2% of the total value of an intended trade available as cash in your account, before you can proceed with the order. This is where margin-based trading can be a powerful tool. With as little as $1,000 of margin available in your account, you can trade up to $50,000 at 50:1 leverage.
Forex margin trading allows you to minimize your financial risk, but the flip side of the coin is that if the value of your trade dropped by the $1000 you put forward it would be automatically closed out by the broker. This is called a ‘margin call’. When trading on leverage, you are in effect “borrowing” money from your forex broker. The funds in your account (the minimum margin) actually serve as your collateral. Therefore, it is only logical that your broker will not allow your account balance to fall below the minimum margin.
Individual brokers may handle margin calls differently. For example, you could receive a request to add more funds to your account, or your broker may simply close your open positions at the current Forex market price to limit further losses. In either case, you could end up losing the entire balance of your account and may even owe additional funds to cover your losses.
Although it’s impossible to eliminate all the risks associated with trading on margin, there are ways to better manage and reduce your overall risk and exposure to the Forex. It’s common for traders especially beginners to think they must win on every trade executed but in fact this is the very mindset that leads to the failure of 95% of those who trade Forex.
The most important element of trading when using leverage is protecting your trading account. While it’s impossible to predict the currency exchange rates it’s not impossible to prepare for the worst. As a general rule of thumb, Forex traders should attempt to protect each trade with a stop loss of no more than 2% of the total account value. Trading Forex is about playing the odds, having a plan and respecting leverage. Risking no more than 2% on each trade will allow you to increase your odds and chances of being successful.
Forex trading utilizing margin is risky business, but by getting the balance right between your level of risk and how heavily leveraged your account is you can gain an advantage. This advantage could be the difference between success and failure. Knowledge is key… learn from techniques and tips of other experience traders. Be mindful of economic news that affects the trade and be sure to take well calculated and well planned steps in pursuing your success in the Forex market.