Leverage and Margin
The leverage available in forex trading is one of main attractions of this market for many traders. Leveraged trading, or trading on margin, simply means that you are not required to put up the full value of the position. Forex provides more leverage than stocks or futures. In forex trading, the amount of leverage available can be up to 200 times the value of your account.
There are several reasons for the higher leverage that is offered in the forex market. On a daily basis, the volatility of the major currencies is less than 1%. This is much lower than an active stock, which can easily have a 5-10% move in a single day. With leverage, you can capture higher returns on a smaller market movement. More importantly, leverage allows traders to increase their buying power and utilize less capital to trade. Of course, increasing leverage increases risk.
Margin Trading: Stocks vs Forex
The word "margin" means something very different in forex than it does in stocks. With stocks, trading on margin means that a trader can borrow up to 50% of a stock's value to buy that stock. This can be a costly move because the investor must pay interest to the brokerage firm on the amount borrowed. This is not the case in forex trading. * For example, at $400/share, 100 shares of Google are valued at $40,000 ($400 x 100 shares). To trade this stock on margin, the money required for the trade is 50%, or $20,000. The remaining $20,000 is borrowed and interest must be paid on that amount. Margin interest is different from broker to broker, but a good rule of thumb is typically Prime plus 1-3% or more. In forex, margin is the minimum required balance to place a trade. When you open a forex trading account, the money you deposit acts as collateral for your trades. This deposit, called margin, is typically 1% of the value of the position. * For example, if you want to purchase $100,000 of USD/JPY at 100:1 leverage, the money required is 1%, or $1000. The other $99,000 is collateralized with your remaining account balance. You pay no interest. It is very important to remember that increasing leverage increases risk. You should monitor your account balance on a regular basis and utilize stop-loss orders on every open position in an attempt to limit downside risk.