The Forex industry is a very interesting one in that Forex traders have the ability to trade in far more currency than their principal investments would generally allow. This is the result of what's known as a "trading margin." So what is this trading margin, and why exactly should you care? Let's talk about it!
Forex Trading Margin: What Is It?
A Forex trading margin is a ratio that defines the leverage a trader has in the market. Trading margins in the world of Forex range from 10:1 to 50:1 on average. So, when it comes to Forex trading, a $1 principal investment gives the trader the ability to trade from $10 to $50 worth of currency.
Forex Margins Are the Same as Stock Market Margins...Right?
For the most part, Forex margins and stock market margins are about the same. However, there are a few key differences:
- Margin Interest - A trading margin is essentially a loan. For every dollar the investor puts up, the broker adds a significant amount of money in Forex. However, Forex brokers generally don't charge interest on the money they put toward your investments. On the other hand, stock brokers generally charge interest on these loans.
- Margin Size - In the stock market, brokers generally offer 2:1 margins; however, in the Forex market, the minimum margin a trader will generally find is 10:1. Therefore, Forex margins give traders more leverage in the market than stock market margins.
- Margin Calls - Forex traders generally aren't susceptible to margin calls. Unfortunately, that's not the case for stock market investors. A margin call happens when a trade moves against the trader. At this point, brokers will require the investor to add to their cash deposits.
Forex Trading Margins: Why You Should Care
Margins can work for you, and they can work against you. To be profitable in Forex, it's important to understand the advantages added by margins as well as the risks. Here's how the advantages and risks work:
- Added Advantage - Think about what leverage really does for Forex traders. With $200 as a principal investment and 50:1 leverage, Forex traders can take advantage of movements on $10,000 worth of currency. That gives traders a big advantage when it comes to realizing gains in the market.
- Risks - On the other hand, high margins can also work against you. That's because when trades don't go in your favor, the size of the loss you take will be increased by the margin.
If you're looking to trade Forex, it's worth the time to do a bit of research on trading margins and how they can help you as well as hurt you. Leave a comment below if you have any specific questions!
This article was written by Joshua Rodriguez, owner and founder of CNA Finance.