Making a good faith deposit with a broker in order to establish and maintain positions in one or more currencies is known as margin trading in the forex market. Margin is a fraction of the customer’s account balance that is put aside in order trade; it is neither a cost or a charge. Depending on the brokerage company, different margin requirements may apply, and the technique has a variety of drawbacks.
Margin Accounts: An Overview
At its foundation, a margin account is borrowing to expand the size of a position and is often an effort to boost returns from trading or investing. For instance, while purchasing stocks, investors often utilize margin accounts. They can hold a greater stake in shares thanks to the leverage provided by the margin than they could have done with only their own funds. Currency dealers in the forex market also employ margin accounts.
Key Points
- In order to start and maintain a position in one or more currencies while trading forex on margin, a good faith deposit is required.
- Trading on margin entails using leverage, which raises the risk and possible rewards.
- The margin requirement varies per forex broker and is often expressed as a percentage of the size of the forex holdings.
- One percent margin is common in the forex market, allowing dealers to control $100,000 worth of currency with only $1,000.
Brokerage companies provide investors with margin accounts that are updated in response to changes in currency prices. Forex traders must first create an account with a forex broker or an online forex broker in order to begin trading. A margin account is created after an investor creates and finances the account, at which point trading may start.
Example of Forex Margin
Before a deal can be executed, an investor must fund the margin account. The amount that must be deposited is determined by the broker’s mandated margin percentage. Accounts that transact in 100,000 or more units of currency, for instance, often have a margin percentage of either 1 percent or 2 percent.
Therefore, a 1 percent margin would need $1,000 to be placed into the account for an investor who wishes to trade $100,000. The broker contributes the remaining 99 percent. The margin’s size is determined by the company’s rules. A greater margin may also be needed by certain brokers to retain trades over the weekend owing to increased liquidity risk. Therefore, if the normal margin is 1% during the week, it can rise to 2% on the weekends.
The $1,000 serves as a kind of security deposit for the broker in a margin account. The broker may issue a margin call if the investor’s position deteriorates and their losses become close to $1,000. When this happens, the broker will often provide the client instructions to either add additional funds to the account or liquidate the transaction in order to reduce risk for both parties. The brokerage may liquidate the account in cases when accounts have suffered significant losses in choppy markets and then subsequently notify the client that their account was the subject of a margin call.
