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Understanding Margins When Trading in Forex

June 30, 2009 by  
Filed under Forex Market

Margin trading can be a beneficial tool for investors involved in regular Forex trading because it provides more purchasing power since you are using other people’s money. But margin trading can also be very hazardous. Here is a very brief overview of how to use margins when you are trading in the Forex marketplace.

When you borrow money to make a purchase of currency pairs you will have to set up a margin account. Margin account requirements are designed to protect Forex traders brokers from suffering huge losses when a trader loses a lot of money. The amount you may borrow is governed by the amount you have in your account. Your account balance must be adequate in the broker’s eyes to cover your outstanding loans. Generally brokers will establish a ratio such as 40 to 1 or 25 to 1.

Since the margin requirements might vary some from one Forex broker to another, investors usually look for the highest margin ratios. Forex brokers generally don’t charge interest on these loans. Instead, they make their money from the spread — that is the difference between the bidding price and the asking price of the currency pairs.

Should your experiences losses that drop your account balance below the required ratio, your account will be closed and the account balance used to cover any outstanding losses. This is called a margin call. It’s a good rule, then, to maintain a comfortable buffer in your account. No one wants to experience a margin call.

By the way, margin rates can at times vary based on the currency pairs that you are trading. When you are trading more common currency pairs they will frequently require lower account balances than more exotic pairings.

Some of the more established Forex brokers provide their customers with routine warnings whenever their account is coming close to receiving a margin call. However, it is up to the trader to understand the rules governing their trades and how their broker conducts margin calls. Most trade agreements clearly state that a margin call can occur whenever a trader’s account balance is insufficient to meet the minimum requirement. The broker is not required to provide advance notice and a margin call may be done swiftly and without prior notification.

Forex investors should pay close attention at all times to their account balances. They should always know how close they are to exceeding the amounts required to keep their accounts in good standing. If you find your account is close to a margin call, the best solution is to simply add money to your account. You will need to add enough to ensure the margin requirement is met.

It is never a good idea to invest more money in any venture than you can afford to lose without drastically altering your style of living. Margin requirements are an intuitive way to keep Forex traders from getting carried away by investing more and more money using a losing strategy.

Some traders may suggest to you that borrowing money is the best way to make money in Forex. That mindset, however, has caused many individuals to quickly lose everything they have due to unforeseen market shifts.

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