Understanding Margin

Trading currencies on margin lets you increase your buying power. Here's a simplified example: If you have $2,000 cash in a margin account that allows 100:1 leverage, you could control up to $200,000 worth of currency-because you only have to post 1% of the purchase price as collateral while FXCM is responsible for posting the remaining 99%. Another way of saying this is that you are leveraged with $200,000 in buying power.

We recommend starting with a Free Demo Account while talking with our 24 hour customer service to practise and learn how the mechanics work. The example below combines information you might gather from a newspaper with the trading platform software and puts it into the context of explanations in our Forex Basics section.

Benefits of Margin

With more buying power, you can increase your total return on investment with less cash outlay. To be sure, trading on margin magnifies your profits AND your losses.

Here's a hypothetical example * that demonstrates the upside of trading on margin:

With a US$5,000 balance in your margin account, you decide that the US Dollar (USD) is undervalued against the Swiss Franc (CHF) and that the price of the listed USD/CHF will rise. For this example, we will use a "standard" account where you will trade 1 lot at a minimum of $1,000 per lot versus a "mini" account where 1 lot would require a minimum of $50 to trade.

To execute this strategy, you are going to "Buy" now and "Sell" later after the price rises.

The current bid/ask price for USD/CHF is 1.6322/1.6327 in reading the newspaper. If you've read the previous sections on interpreting quotes, in the FXCM trading platform dealing box, it would show the price listed as:

"Sell" - 1.6322 and
"Buy" - 1.6327

(In actual terms, this really means you can "Buy" $1 US for 1.6327 Swiss Francs or sell $1 US for 1.6322)

You execute the trade as a "Buy" of one lot at 1.6327. In actual terms, one lot is $1,000 from your account. The translation is that you are actually buying $100,000 US dollars and selling 163,270 Swiss Francs with your available leverage at 100:1 or 1%. Your responsibility is 1% while FXCM's responsibility is 99% of the transaction based on leverage.

So, at 100:1 leverage, your initial margin deposit for this trade is $1,000. Your account balance is now $4000.

Suppose the next day, as you expected, USD/CHF rises to 1.6435/40 which you see in the newspaper. So, the dealing box on in the FXCM trading platform dealing box, it would read:

"Sell" - 1.6435
"Buy" - 1.6340

You can now sell $1 US for 1.6435 Francs or "Sell" off your 1 lot at a higher valued Franc.

To take a profit, you close out the position, selling one lot at 1.6435 which means you are (selling 100,000 US dollar and receiving 164,350 CHF) Since you originally sold (paid) 163,270 CHF, your profit is 1080 CHF.

To calculate your P&L in terms of US dollars, simply divide 1080 by the current USD/CHF rate of 1.6435. Your profit on this trade is $657.13.

* Note that the FXCM trading station calculates all of this for you while this is simply an exercise to help your understanding behind the scenes.

SUMMARY

Initial Investment: $1000

Profit: $657.13

Return on investment: 65.7%

If you had executed this trade without using leverage, your return on investment would be less than 1%.

Trading on margin can be a profitable investment strategy, but it's important that you take the time to understand the risks. Feel free to either do a "live chat" with our 24 hour help desk or call us anytime to get a better understanding on how this works.

The positions in your account could be partially or totally liquidated should the available margin in your account fall below a predetermined threshold.

You may not receive a margin call before your positions are liquidated. You should monitor your margin balance on a regular basis and utilize stop-loss orders on every open position to limit downside risk.

* "Hypothetical performance results have many inherent limitations. No representation is being made that any account will or is likely to achieve profits or losses similar to those shown. In fact, there are frequently sharp differences between hypothetical performance results and the actual results subsequently achieved by any particularly trading program.

One of the limitations of hypothetical performance results is that they are generally prepared with the benefit of hindsight. In addition, hypothetical trading does not involve financial risk. Variables such as the ability to adhere to a particular trading program in spite of trading losses as well as maintaining adequate liquidity are material points which can adversely affect actual real trading results."