Forex Margins and Leverage

Two terms that will quickly come to the attention of anyone interested in online forex trading are margin and leverage.

Margin, simply defined, is the amount of money that a forex broker will require you to have in your account in order for that broker to permit you to engage in currency pair trading. The amount varies from broker to broker, but it essentially acts as insurance to the broker that you will be able to cover any trading losses you may incur. The higher the amount of margin you deposit to, and maintain in your account will determine how many currency units will be made available to you.

Most forex broker trading platforms will inform you of how much margin a particular currency transaction will require, and if you enter into that transaction, how much margin you have remaining for your use.

If your trading losses exceed a certain percentage of your trading margin, and this also varies according to the broker, your broker will issue a margin call. This is a bad predicament to find oneself in, because the margin call requires you to immediately deposit additional money to cover your losses, otherwise the broker will close all of your open trades.

Most modern brokers will clearly divulge at what level of loss this will happen, and many will also configure their trading platforms to close losing open positions before it is necessary to issue a margin call, which when you look at it objectively, is a good thing. The other term, leverage, simply defined, is the amount of currency you can control for the amount of margin you willing to risk on a trade.

Traders in the U.S. can receive a maximum leverage level of 50:1, meaning that for every $50 of currency they wish to control, they must put up a margin of $1. Traders in the rest of the world receive higher leverage levels, some as high as 400:1, meaning that $400 worth of currency can be controlled for a $1 margin deposit.

Many brokers will offer variable, trader selected levels of leverage. The easiest way to understand leverage is to try various levels, then observe the varying number of available currency units as a result. You will soon see that the higher the leverage level selected, the more currency units are available.

Leverage is a classic example of the two-edged sword. High leverage levels make higher profits possible, but they also make it extremely easy to refuse to acknowledge a bad trade, and instead of exiting that bad trade while its losses are small, continuing to add currency units to it in an attempt to move the average entry price of the trade closer to the market and hope for a reversal of price direction.

The best advice regarding how to use leverage is to begin with lower levels until you gain the experience in how far and how fast the market for the currency pairs you wish to trade typically moves during a typical trading session.

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