Margin is a good faith deposit to ensure against trading losses. In the financial world, it is a common practice now for foreign exchange to be traded on margin, which means for a small outlay one can open up much larger position in the market. Margin trading is also known as leverage trading. Leverage is a double-edged sword. It can dramatically amplify one’s profit and amplify one’s losses just as well. Trading foreign exchange with a high or even moderate level of leverage may not be suitable for all investors. A simplified example: If you have $2,000 cash in a margin account that allows 1:100 leverage, you could purchase up to $200,000 worth of currency because you only have to post 1% of the purchase amount as collateral. Another way of saying this is that you have $200,000 in buying power.
To start trading on margin, one has to open a margin account with a brokerage house which will allow the investor to invest with a relatively small amount of cash upfront by using the assets currently held in the account as collateral. Most brokerages generally allow cash and/or securities as a form of collateral.
To open a FX position, a minimum amount which is known as initial margin requirement will be required. Thereafter, the amount required to be kept in collateral until the position is closed is the maintenance margin requirement. The maintenance margin requirement is the minimum amount to be collateralized in order to keep an open position. It is generally lower than the initial margin requirement. This allows the price to move against the position without forcing a margin call immediately after the initial transaction.
When the margin posted in the margin account is below the minimum margin requirement, the broker or exchange will issue a margin call. The investor will have to either increase the margin that he has deposited or close out his position(s). If the investor does not perform either option, the broker will take action upon the investor’s behalf to prevent overloss to the account. The broker does have the rights to close out clients’ positions without first consulting the clients.
In general margin trading is a risky business since it provides a way to magnify your trading power. It is essential that the investor understands the risks that are associated with margin trading before begin trading on margin. Discipline in trading is the key. Learn How To Trade.