Understanding Margin Trading
Trading currencies on margin lets you increase your purchasing power. It lets you buy currencies worth much more than you have actually deposited. For example, if you have $1,000 cash in a margin your account and if your broker allows 400:1 leverage, you could purchase up to $400,000 worth of currency, because you only have to post 0.25% of the purchase price as collateral. So, now you have the purchase power higher by 400 times than your actual buying power.
Margin or leverage can be considered a double-edged sword. You need to have a proper risk management system at place to avoid high degree of loss with margin trading. You must remember that high leverage can lead to large losses as well as gains.
Benefits of margin trading are therefore quite evident. With more purchasing power, you can increase your total return on investment with less investment. With an initial investment of say $250.00, your return on investment can be as high as above 250%. But, it is better that you understand how your margin account works. Always read carefully the margin agreement between you and your broker firm.
You should never forget that the positions in your account could be partially or totally liquidated if the available margin in your account falls below a predetermined threshold level. You may not receive a margin call before your positions are liquidated and therefore should always keep a tab on your margin balance on a regular basis and utilize the stop-loss orders on every open position to limit the risk.
If you trade forex with an automated trading platform, it calculates the margin requirements and checks your available funds before allowing you to successfully enter a new position. If you do not have adequate funds, you receive an “insufficient margin funds” message while attempting to enter a position. More is the leverage, more the opportunity, and more the risk.