Understanding the concepts of leverage and margin is one of the most important areas that every trader needs a solid grasp of in order to be successful. If you’re caught up in the Forex market, then it’s safe to assume that you’re here to make money. In order to make money, you have to know and practice good risk management so that you limit your chances of loss and increase the odds of success.
Without practicing safe money management, you are basically gambling your money away. You wager a certain amount of your budget with the “hopes” that the market moves in your direction for a profit. Using this tactic, you might as well play the lottery. By adhering to a set of safe risk management rules, you will limit losses and increase your odds of success. To do this, it’s important to determine these rules before you participate in live trading and ensure they are implemented all the time.
Your Bankroll
The initial amount of money you decide to deposit into your brokerage account will often times determine how successful you will be. It’s a sad truth, but an honest one. This is the reason why banks, wealthy investors, and various institutions such as hedge funds do so well. They all have enough money to survive the swings of the market.
Now, there are many brokers available who will allow you to make small deposits as low as $25 USD or so. This doesn’t mean that it’s a good idea though. Traditionally the rule of thumb says to start off with $10,000 - $50,000 USD in your account. This will allow you to take some losses as you learn and stay in the game at the same time.
There are a few different types of accounts for which you can establish and trade from. They are: Standard, mini, micro, and nano. A standard account really needs a deposit of $50,000 - $100,000 USD to ensure success. A mini account can be funded with $10,000 USD, and a nano account is reasonable for a $500 USD deposit. These amounts are not set in stone by any means, but they will go a long way to helping you stay trading.
The Forex market basically goes up and down over time. It may take a week or so for the market to change directions and move back to your position for a profit, but it will maintain itself within a certain dollar amount. The more money available in your broker account, the longer you can withstand the fluctuations until you see positive results.
Leverage
Leveraging your money simply means that the amount you choose to secure your position will be frozen, and your broker will provide you with X number of dollars for each dollar you put up to trade with. So if you use $1,000 USD and your leverage is 100:1, then your $1,000 USD will allow you to trade with $100,000 USD.
Successful traders will only risk between 2 - 5% of their account on any single trade. This means that a $10,000 USD account will only use $200 - $500 USD at one time. If you are leveraged 100:1, then your $500 USD will allow you to trade with a $500,000 USD position.
The amount you choose to leverage with will not only mean a larger return on your investment, but also the same possible loss of your investment. A 400:1 leverage on $100 USD gives you $40,000 to trade with. Each pip towards or away from your position will either increase or decrease the amount of equity you have in your account. Assuming you are leveraged at 100:1 for $1,000 USD, you can trade with $100,000 USD in the market. On the other hand, leveraging at 50:1 will require you to have $2,000 in order to secure the same position for trading. The lower your leverage, the less risk is involved, but you will get a lower return on your money.
Margins
When trading in the market, the amount of money you have in your broker account directly correlates with the amount of margin you have available. The dollar amount that you choose to put into trade is basically frozen as a “good faith deposit” in order to secure your leveraged position. The platform (software) you are using to trade with will tell you what your used margin is as well as your available margin and equity. Your equity is the amount of money you have at any specific time if you were to liquidate all of your positions.
This means that the money first set aside as a good faith deposit is put on hold while you trade. If you lose money, then your broker will close your position, refund your deposit, and deduct your losses from you broker account. If you owe more than the predetermined amount set by your broker for losses, you will receive a margin call where the broker will close one or more of your open positions in order to cover the amount you owe. This is why wealthy individuals and institutions are successful. They have more available money to cover any losses until the market reverses its direction. A new trader with an account size of $100 will only be able to withstand a couple of negative trades before depleting his account.
Always keep in mind to practice safe money management skills, ensure that you have sufficient funds in your account to survive market fluctuations, and practice as much as you can before trading on a live account. It is better to break even and live to trade another day than to blow your account and have to deposit more funds before trading continues.
Jefferson Hightower - I have written freelance articles on business, personal finance, cooking, parenting, and much more. I've written blogs for various ...
