Leverage and Margin can also be a Deadly Combination

Jul 25 • Forex Trading Articles • 1398 Views • Comments Off on Leverage and Margin can also be a Deadly Combination

You were forewarned. Indeed, leverage and margin can put an end to your foreign exchange career if you do not fully understand the underlying principles and concepts behind them. These two are commonly referred to as the major attraction in the world of foreign exchange trading given the fact that these create a possibility for you to purchase despite the fact that you have only a limited capital.

To put it simply, trading different currencies in a foreign exchange market with leverage and margin gives you the opportunity to shoot up your purchasing capacity. To put it simply, if you only have $5,000 capital in a live forex margin account that enables you to have a 200:1 leverage. Then you can trade up to a million dollars worth of currency simply because of the fact that you only have to post half a percentage (0.5 %) of the price needed to purchase as your collateral amount. In other words, your $5,000 dollar suddenly has $1,000,000 worth of buying capacity.

But with great purchasing power also lies a possibility of having greater responsibility. Yes, you can shoot up dramatically the overall return on investment using the least amount possible as your capital. Likewise, if you do not proceed with due caution, trading in the foreign exchange market with leverage and margin can give you losses that are way beyond your capability to pay back.

What is a margin call?

If there is one thing that many traders fear, it is the margin call. This happens when your own broker gives you a notification that the margin deposits that you have made at the onset fell below the critical level. In other words, the open positions that you have acquired for a trade have suddenly moved against your account. This aspect of leverage and margin is one of the most difficult to absorb because this requires a thorough knowledge about risks.

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In order to survive, the following tips might be helpful in order to avoid the scenario wherein the leverage and margin becomes a deadly combination:

  • Double check if you have enough understanding about the dynamics of a margin account. Before agreeing to the terms given to you by your broker, make sure that you have thoroughly read the agreement. Remember that you can ask questions anytime about the agreement if you find any aspect or specifics unclear or unacceptable.
  • If you find yourself in a situation in which your live forex account falls way below the critical level, do not panic. You still have other options. Take note of the fact that the positions may be totally or partially liquidated if your available margin has evaporated. Before liquidation of your positions, you may or may not receive a margin call.
  • If your usable margin has fallen below the requirements of a live account, the broker will surely close all or some of your open positions. This keeps your account from bearing a negative balance despite the market that is moving in a fast and volatile manner.

In the end, you can veer away from margin calls if you know how to appropriately use the principles of leverage and margin.

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