What are Margin and Leverage

Q. What are "margin" and "leverage"?

Probably the biggest reason that Forex is so popular is because a very high return on a small investment is possible and a large amount of money can be controled with a small amount of money. Why? Because of very liberal Forex margin and leverage requirements.

Margin requirements are set by your Forex account broker. Margin gives the Forex trader great leverage in trading. This is how it works. If a trader were not allowed to use margin to trade it would mean that for every lot traded the trader would have to put up in cash the full value of that lot. A lot is equal to 100,000 units of a currency. So, if a trader wanted to buy one lot of Euros when the exchange rate was $1.2822 per Euro, the trader would have to have $128,220 in cash in his trading account to back up his trade. That's a huge sum of money and at that rate most traders would not be able to enter the market at all.

With margined trading at 100 to 1 (100:1), however, the trader only has to have in his trading account 1/100th of the cash value of the traded currency. So, to buy one lot of Euros with U.S. Dollars the trader only has to have $1,282.20 in his trading account. At 200:1 only $641.10 would have to be in the trading account. If the trader wanted to buy two lots of Euros then there would have to be a minimum of $2564.40 in the trading account.

The word "leverage" is used to describe the fact that $128,220 worth of Euros is being controled - traded - using only 1/100th of that amount as collateral. You can use the concept of a mechanical lever to understand how it works. Using a long mechanical lever one can move a giant weight with not much force.

Most Broker/Market Makers allow traders to trade with 100:1 margin. Some even allow 200:1 margin. Before opening an account with a broker Market Maker every trader should know what the margin requirements are.

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