Forex Trading Tutorial - Tutorial For Trading The Forex With Financial Leverage & Power

by Nigel Banks

Did you know it is not the markets movements that make the Forex such a powerful tool for financial gain? The fact is when it comes to wild market swings, the stock market is probably the hands down winner with point moves in the hundreds. So why then is Forex so much more powerful than NYSE? The answer is in leverage.

Normal markets like stocks require that you have the exact money for the position you are trading. In other words they are a cash and carry type of market. The Forex is completely different in that you are only required to make a deposit on the trade, your broker will cover the rest of the money. This means that you are controlling a much larger position that you have to put up cash for. It is a bit like buying a $400,000 house with only 10% down. You only put down $40,000 dollars but you now control an asset worth ten times as much.

Here's where Forex Trading really begins to shine. Unlike the real estate market the Currencies move up and down a significant amount in minutes and hours instead of months and years. And unlike real estate the leverage is many times greater, to the order of 200:1 or even 400:1. This means that to control a $100,000 in currencies at a 400:1 leverage you would only need to have a .25% deposit on hand, which equals $250. Thus the power of leverage - if that market rises only 1% in a day the total gain would be $1000 for a risk of $250. This would yield a 400% return on investment with only a 1% market move.

Do you see the power of leverage now?

The Dreaded Margin Call

Of course, if a market can go up and make tremendous gains on leverage, it can also go down and have you losing money by the same amount of lever. So a 1% down turn in the market scenario mentioned above would have you losing $1,000 instead of gaining.

The brokers know this risk and have gone to great lengths to cover themselves by requiring what is called a maintenance margin. This maintenance margin is usually equal to the amount of leverage used in trading. So if you were trading at 200:1 leverage a 2% maintenance margin would be mandated.

When your losses have taken your account below the funds that are required to be above that maintenance margin, your broker will have the unpleasant duty of calling you on the phone and telling you to deposit more money or exit your trade position. You will then need to scramble an electronic transfer of cash in order to keep the privilege of trading your account. The Maintenance margin and the margin call are means for the brokers to protect themselves from losing money by having to cover traders losses at the end of each day.

As scary as these calls may be they are usually only received by people who do not know how to properly manage their trading account.