Margin can be thought of as a good faith deposit or collateral that’s needed to open a position and keep it open.
Margin trading gives you the ability to enter into positions larger than your account balance.
Although buying and selling on margin does not provide leverage in and of itself, it can be used as a form of leverage.
This is because the amount of margin you are allowed to take out typically depends on how much money you have in your account.
Trading currencies on margin let you increase your buying (and selling) power.
This means that if you have $5,000 cash in a margin account that allows 100:1 leverage, you could trade up to $500,000 worth of currency because you only have to post one percent of the purchase price as collateral.
Another way of saying this is that you have $500,000 in buying power.
With more buying power, you can increase your total return on investment with less cash outlay. But be careful, trading on margin magnifies your profits AND losses.
Margin Call
All traders fear the dreaded margin call.
It’s not a great feeling.
This occurs when your broker notifies you that your margin deposits have fallen below the required minimum level because an open position has moved against you too much.
While trading on margin can be profitable, it is important that you take the time to understand the risks.
Make sure you fully understand how your margin account works, and be sure to read the margin agreement between you and your broker.
Always ask any questions if there is anything unclear to you in the agreement.
Your positions could be partially or totally liquidated should the available margin in your account fall below a predetermined threshold.
You may not receive a margin call before your positions are liquidated (the ultimate unexpected birthday gift).
In the event that money in your account falls below margin requirements (usable margin), your broker will close some or all open positions.
This can help prevent your account from falling into a negative balance, even in a highly volatile, fast-moving market.
Margin calls can be effectively avoided by monitoring your account balance on a very regular basis and by utilizing stop loss orders on every open position to limit risk.
Keep in mind though that your stop loss may experience massive slippage when the market is moving fast!
The topic of margin is a touchy subject and some argue that too much margin is dangerous. It all depends on the individual and the amount of knowledge and training he or she has.
If you are going to trade on a margin account, it’s vital that you know what your broker’s policies are on margin accounts and that you understand and are comfortable with the risks involved.
You should also know that most brokers require a higher margin during the weekends. This may take the form of 1% margin during the week and if you intend to hold the position over the weekend it may rise to 2% or higher.
Brokers also may have different margin requirements for different currency pairs so pay attention to that as well!
