Margin trading in the forex market is the process of making a good faith deposit with a broker in order to open and maintain positions in one or more currencies. Margin is not a cost or a fee, but it is a portion of the customer's account balance that is set aside in order trade. The amount of margin required can vary depending on the brokerage firm and there are a number of consequences associated with the practice.
Understanding Margin Accounts
A margin account, at its core, involves borrowing to increase the size of a position and is usually an attempt to improve returns from investing or trading. For example, investors often use margin accounts when buying stocks. The margin allows them to leverage borrowed money to control a larger position in shares than they'd otherwise be able to control with their own capital alone. Margin accounts are also used by currency traders in the forex market.
Key Takeaways
- Margin trading in forex involves placing a good faith deposit in order to open and maintain a position in one or more currencies.
- Margin means trading with leverage, which can increase risk and potential returns.
- The amount of margin is usually a percentage of the size of the forex positions and will vary by forex broker.
- In forex markets, 1% margin is not unusual, which means that traders can control $100,000 of currency with $1,000.
Margin accounts are offered by brokerage firms to investors and updated as the values of the currencies fluctuate. To get started, traders in the forex markets must first open an account with either a forex broker or an online forex broker. Once an investor opens and funds the account, a margin account is established and trading can begin.
Forex Margin Example
An investor must first deposit money into the margin account before a trade can be placed. The amount that needs to be deposited depends on the margin percentage required by the broker. For instance, accounts that trade in 100,000 currency units or more, usually have a margin percentage of either 1% or 2%.
So, for an investor who wants to trade $100,000, a 1% margin would mean that $1,000 needs to be deposited into the account. The remaining 99% is provided by the broker. The amount of margin depends on the policies of the firm. In addition, some brokers require higher margin to hold positions over the weekends due to added liquidity risk. So if the regular margin is 1% during the week, the number might increase to 2% on the weekends.
In a margin account, the broker uses the $1,000 as a security deposit of sorts. If the investor's position worsens and their losses approach $1,000, the broker may initiate a margin call. When this occurs, the broker will usually instruct the investor to either deposit more money into the account or to close out the position to limit the risk to both parties. In situations where accounts have lost substantial sums in volatile markets, the brokerage may liquidate the account and then later inform the customer that their account was subject to a margin call.
