Your broker needs a so-called good-faith deposit from you. Moreover, you as a trader are not using the deposit as payment, or to purchase currency units. This mechanism ensures the broker against any potential losses. Margin trading has another big advantage: it allows leverage.Īs you can see in our example, your initial deposit serves as a guarantee for the leveraged amount of 100,000 USD. In other words, you can trade with a loan from your broker, and that loan amount depends on the amount you initially deposited. This is why margin trading is trading with borrowed capital. Instead, you will have to put down a deposit that we call margin. If you purchase a USD/JPY standard lot, you don’t need to put down 100,000 USD as the full value of your trade. whether the exchange rate has moved in your favor or against your initial speculation). In other words, you estimate how the exchange rate will move, and you make a contract-based agreement with your broker that he will pay you, or you will pay him, depending on whether your estimation has proved to be correct or wrong (i.e. Practically speaking, what you do is speculate on the exchange rate. When you carry out a forex transaction, you don’t actually buy all the currency and deposit it into your trading account. But how can you buy 100,000 USD/JPY with only USD 1,000? Basically, margin trading involves a loan from the forex broker to the trader. 100,000 of USD/CHF), you need to maintain only 1% of the traded amount in your account i.e. And so, in order to buy 1 standard lot (i.e. If you trade on a 1% margin, for instance, for every USD 100 that you trade, you need to put down a deposit of USD 1. Margin is the minimum amount of funds, expressed as a percentage, that you will need if you want to open a position and keep your positions open. Why? Because currency rates change all the time, and you want to know when to buy one currency and when to sell another to make a profitable deal. It depends on a great deal of social and economic factors, many of which you’ll be watching more closely when you start trading forex. The when is a question that nobody can answer precisely. Okay, but when? If you’re a time freak like me, the when is important to you, too. The exchange rate may change in 2 days or 1 week, though. Maybe I’ll wait until the euro gets stronger before I exchange it and fly to Tokyo again. Now take a quick peek at how the euro is doing against the Japanese yen: for 1 euro I can get 106.53 Japanese yen (i.e. This means that 1 euro (the base currency) is equal to 1.3115 US dollars (the quote currency). The exchange rate shows you how much of the quote currency you need if you want to buy 1 unit of the base currency.Įxample: EUR/USD = 1.3115. It is the rate at which you exchange one currency for another.
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