For any forex trader, it is essential to understand two concepts: leverage and margin. Leverage lets traders to into currency trading using an amount that is actually more than what is available in their respective accounts. With this, forex traders have the chance to have “bloated” funds. Meanwhile, margin refers to the actual funds needed for a trading account to be considered as collateral that is necessary to cover potential losses.
A closer look into leverage
Compared to the stock market, traders within a forex market are more vulnerable to losses. Fortunately, forex trading promises higher profits, but the risks remain high. Most brokers allow a leverage of 100:1. It means one can buy or sell €100,000 worth of currencies. This is possible even if you have only around €1,000 worth of currencies in your account. In some cases, brokers may even allow having a leverage of 400:1.
Traders must also understand that leverage in Forex can also be used against them. For instance, when a currency moves against the set expectations, the leverage may bring major losses. A lot of people remain clueless on the importance of leverage and margin, most especially those who are just starting out in forex trading. Leverage sounds to be an amazing element for most traders, but forex traders should know that even the smallest fluctuation of currency rates may mean loss of the entire capital. Given this, it seems safer to depend on a smaller leverage so that huge losses can be prevented. Bearing this in mind, forex traders must always apply a perfect balance in each move they do.
Role of margin in forex money management
As mentioned in the example above, if a trader buys €100,000 worth of currencies, he or she is technically borrowing €99,000 worth of the purchase. The €1,000 of the said transaction serves as the margin, which is used to cover the potential losses during the trade.
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Forex traders always have the freedom to choose even the higher leverage, which is 200:1 that has a margin of 0.05%. However, if you want to practice money management rules in forex, you better try a safer option. For each option, forex traders should closely analyze the potential losses, and not just the profit they want to gain.