Trader Education
Forex margin trading – how does it work?
28 Feb 2013
A margin account is intended to maximise return on investment by borrowing. Investors whose invested capital can control a certain amount are able to use the borrowed sum’s leverage to control a larger position. Margin accounts are settled in cash on a daily basis and may be used both in equities and, in the forex market, by currency traders.
To trade in forex, an investor first signs up with either a regular broker or a discount forex broker who operates online. Next, the investor creates a margin account, which operates similarly to a margin account in equities: the broker loans to the investor, on a short-term basis, a sum equivalent to the leverage the investor is taking on.
Before trading begins, the margin account must be supplied with money; the broker and investor agree a margin percentage, which determines the sum to be deposited. This is often 1% or 2% when the account is to trade at levels at or above 100,000 currency units. An investor with a 1% margin intending to trade $100,000 would therefore deposit $1,000.
The broker makes up the rest of the money – 99% in this example. Although the borrowed sum attracts no interest, investors who fail to close their positions by the delivery date will find them rolled over. At this point, depending on the underlying currencies’ short-term interest rates and on the investor’s position, interest charges may apply.
The broker uses the $1,000 in the margin account as security. Should an investor’s position worsen sufficiently that losses near $1,000, a margin call may be initiated by the broker. At this point, it is usual for the broker to tell the investor either to deposit a further sum or close out the position, thus limiting both parties’ exposure.
