The meaning of 'Margin' in stock is not the same when it comes to forex. They simply mean different thing.
Margin trading
In stocks trading you need about 50 percent margin to trade which is very high. An example is this, if the value of microsoft shares is valued at $300/share, purchasing 200 units wil require you to pay $60,000 ($300 multiply by 200 units), and when you use margin, you will pay about $30,000 for the value of those 200 units.
The rest of the money is borrowed, and interest is being paid on such money. So as you can see, margin trading in stock is quite expensive, interest focused, and not suitable for all traders.
In forex, margin trading is something more interesting. Margin is the smallest money that you are required to open a trade. When an account is opened, the deposit you pay is the margin, and it is basically 1% of the worth of the position. As an example, when you purchase about $100,000 of USD/JPY, and this is at a leverage of 100:1, the amount that is required is only 1% which is about $1,000.
Where is the other $99,999 coming from?
The other money is collaterized with the rest in your account, and another interesting thing, you will not be paying any interest. You should also be aware that when you increase your leverage, you consequently increase your risk. The only way to reduce this risk is to watch your account balance on a regular basis, and also make use of stop-loss orders to cut down losses.
Lets give you a demostration of the effect of leverage.
If you have an acount balance of $5,000, and you want to purchase the USD/CHF pair, because you think the USD will rise in value. Ok thats a good one. At a current bid/ask price of 1.2300/1.2305, which you can sell 1 USD for 1.2300, and buy CHF for 1.2305. The spread is 5 pips, take note of that.
If your leverage is 100:1, your first deposit will be $1,000 for this trade.
And if at your speculation, the rise moves from its intial cost to 1.2380/1.2385, which is considered a rise of 80 pips, you need to sell off your USD for the CHF. Now selling price will be at 1.2380. So selling your position gives you a profit of about 750 CHF. Converted to USD, you will have a profit of $605.
This calculation is arrived at by dividing the profit in CHF by the current rate (750 divided by 1.2380).
In summary, you bought a trade with $1,000, and made $605 as profit, you return is about 60%. So if you bought this trade without the use of leverage, you won't make any significant return, and it will certainly be less than 1%.
Tuesday, July 01, 2008
