Let’s discuss the idea of margin trading, which can be intense, and might not be ideal for every investor or trader.
You know how you have a great business idea, but no money. What do you do? You might look for investors, or go to the bank for a loan. Here, you would try to convince people that you have an idea that will profit immensely, and tell them that they have an opportunity to share in the profit with you.
Well, when you trade – let’s say that you have a great idea. It might be a theory that a country is inflating a currency tremendously, or that the numbers are wrong, or whatever the case may be. You might only have $100 or $1000 to your name, but you want to trade thousands of dollars!
That’s the way to get the big money, right?
Well, you have the ability to margin trade. With margin trading, you can actually conduct very large transactions, without a large amount of capital.
Let’s explore forex margin little bit further.
So, let’s say that for whatever reason, you believe that the British pound will go up against the dollar, and that this will be a very profitable trade for you. You want to purchase a large amount of units to take advantage of this great trade, but you don’t have hundreds of thousands of dollars at your disposal.
You can purchase two standard lots, which is 200,000 GBP units against USD, and you purchase this at 2% margin. Now, let’s say that the exchange rate at the time of the trade is 1.6 GBP to every US dollar. If the margin requirement is 2%, then you can purchase 200,000 pounds at $160,000, and the only requirement is that you set aside $6,400 to cover the trade. Why does it only cost you $6,400? This is because that is what the margin requirement called for, as a result of multiplying $320,000 x 2%.
Now, let us say that your theory proved correct! You decide to close the successful trade at 1.605. Now, this might not seem like much of a difference, but it certainly is profit – and you have earned $1000 just like that!
In this manner, the deposit that you made is returned to you and the resulting profit/loss is credited to your account. Of course, margin trading can certainly be risky, as well. It’s not as if there is some guarantee that your theory will turn out to be true. The idea is that the trader believes in the trade more than usual, and thus is willing to risk more.
For those who want to trade a custom lot number, because of their own personal strategy, or have a “lucky number”, there are now retail forex brokers that even allow for this now.
It should be noted that you have to be careful with margin trading because there is a cut-off time. This means that you can end up paying interest on your margin trade, since it essentially works as a loan. This is important to remember, as this obviously affects your profit/loss to some extent. The cut-off time varies but is usually 5 pm EST.
Interest is PAID on what is borrowed, and EARNED on what is bought, and this is essential to remember, as well.
Because of the new competition among retail brokers, there are all sorts of different brokers that have different offers when it comes to rollover rates, and cut-off times, etc. Make sure to understand this before you choose or switch a broker, as well.