In a previous article, we discussed about proper money management.
Today, let us go deeper into what a forex margin account is all about and why is it important to understand.
Margin is simply using borrowed money to buy or sell a security.
In forex, when you are buying or selling a position, your broker is actually lending you money so as to place your order in the market.
A standard lot in forex is $100 000.
Micro lot is $10 000.
If such money is required, i doubt there will be many retail investors.
Next comes leverage.
Leverage in forex margin accounts simply means the number of times your deposit the broker is willing to lend you.
Having a high leverage can be good or bad as it may amplify both profit and loss.
Your account has $100.
Leverage is 1:200.
Therefore, to place a micro lot of $10 000 in EUR/USD,
you need $10 000 / 200 = $50.
Great! You may feel since the broker is kind enough to help you on your road to riches.
However, not every trade will be profitable and since you are on borrowed money, the broker will not allow the account to fall below the minimum margin.
Example 1 Part 2
After setting the margin aside, you have $50 left.
Since you entered a micro lot, for the eur/usd, per pip = $1 USD.
With the $50 left, this means that you can sustain a maximum of $50 loss before your available money is used up.
Now, with the available money gone due to a losing position, what happens next?
As i mentioned earlier, since the broker is lending you money, the broker will not allow the position to carry on if they lose their own money too!
Since you do not have enough available money to sustain the loss, the broker will close the position and salvage their own money.
This is known as a margin call.
A 50 pip move in either ways is very common in forex and hence understanding your margin and leverage is important so that you can plan for a position with proper money management.
Remember, we are here to survive for the long run.
Do not allow forex to be a short lived endeavour.