Leverage is financed with credit, such as that purchased on a margin
account which is very common in Forex. A margined account is a
leverageable account in which Forex can be purchased for a
combination of cash or collateral, depending what your brokers will
accept.
The loan (leverage) in the margined account is collateralized by your
initial margin (deposit). If the value of the trade (position) drops
sufficiently, the broker will ask you to either put in more cash or sell a
portion of your position or even close your position.
Margin rules may be regulated in some countries, but margin
requirements and interest vary among brokers/dealers so should
always check with the company you are dealing with to ensure you
understand their policy.
Up until this point you were probably wondering how a small investor
can trade such large amounts of money (positions). The amount of
leverage you use will depend on your broker and what you feel
comfortable with. There was a time when it was difficult to find
companies prepared to offer margined accounts, but nowadays you
can get leverage from as low as 1% with some brokers. This means
you could control $100,000 with only $1,000.
Typically the broker will have a minimum account size, also known as
account margin or initial margin e.g. $10,000. Once you have
deposited your money, you will then be able to trade. The broker will
also stipulate how much they require per position (lot) traded.
In the example above, for every $1,000 you have, you can take a lot
of $100,000. So if you have $5,000 they may allow you to trade up to
$500,000 of forex.
The minimum security (Margin) for each lot will vary from broker to
broker. In the example above the broker required a one percent
margin. This means that for every $100,000 traded the broker wanted
$1,000 as security on the position.
Margin call is also something that you will have to be aware of. If for
any reason the broker thinks that your position is in danger e.g. you
have a position of $100,000 with a margin of one percent ($1,000)
and your losses are approaching your margin ($1,000). He will call
you and either ask you to deposit more money, or close your position
to limit your risk and his.
If you are going to trade on a margin account it is imperative that you
talk with your broker first to find out what their policies are on these
types of accounts.
Variation Margin is also very important. Variation margin is the
amount of profit or loss your account is showing on open positions.
Let's say you have just deposited $10,000 with your broker. You take
5 lots of USD/JPY, which is $500,000. To secure this the broker
needs $5,000 (1%).
The trade goes bad and your losses equal $5001, your broker may
do a margin call. The reason he may do a margin call is that even
though you still have $4,999 in your account the broker needs that as
security and allowing you to use it could endanger yourself and him.
Another way to look at it is this: if you have an account of $10,000
and you have a 1 lot ($100,000) position. That's $1,000 assuming a
(1% margin) is no longer available for you to trade. The money still
belongs to you but for the time you are margined the broker needs
that as security.
Another point of note is that some brokers may require a higher
margin during the weekends. This may take the form of 1% margin
during the week and if you intend to hold the position over the
weekend it may rise to 2% or higher. Also in the example we have
used a 1% margin but this is by no means standard. I have seen as
low as 0.5% and many between 3%-5% margins. It all depends on
your broker.
There have been many discussions on the topic of margin and some
argue that too much margin is dangerous. This is a point for the
individual concerned. The important thing to remember, as with all
trading, is that you thoroughly understand your broker's policies on
the subject, that you are comfortable with them and understand your
risk.
