Leverage, Margin and Lot Sizes in Forex

Baazex
/ December 28th, 2018
Introduction to Forex

What Is Forex:

The term “FOREX” is used for Foreign Exchange (also known as FX) which is an online global network used to buy and sell currencies with the daily turnover of $5.1 trillion. It provides the facility to trade 24 hours a day and 5 days a week where banks, individual traders, financial institutions and companies can participate.

There are two major tiers in the forex market, the first one is an interbank market where currencies of different countries are exchanged by the biggest banks. The other one is the over-the-counter (OTC) market where companies and individuals can trade.

With the irregularity within the performance in other markets, the boom of foreign exchange buying and selling, making an investment and control is in an upward direction.

Leverage In Forex:

The potential to hold a large quantity of amount as your capital with little cash of your own account is called leverage. It can also denote the sum of debt an employer uses to finance assets. When one refers to a corporation, assets or investment as “incredibly leveraged,” it processes that item has more debt than equity. As an example, if a forex broker gives you the leverage ratio 1:100 then it means you could trade $200,000 with $2,000.

If you open a trade entirely with your capital of $200,000 using 1:1 leverage ratio, your gain amount will be $2,000 using a 1% return. If you end up with the loss, you will lose your 1% of capital.

Now you have leveraged by a 1:100 ratio. Your broker will use $2,000 amount of your capital for the same trade of $200,000 with the same profit ratio. If you end up with the loss, you will lose all of your invested capital in this trade.  

How to calculate leverage and margin percentage:

The leverage ratio is 1:100

Margin=1/Leverage=1/100=0.01

Margin percentage of 1/100=0.01=1%

Leverage=1/margin =100/margin percentage

Leverage =1/0.01=100/1=100

The Margin In Forex:

For your better understanding remember the previous example that a trader can make a trade of $200,000 with just $2,000 using the leverage of 1:100. So, if the trader wants to do this trade then he will first deposit the “margin” of $2,000 in his account if the account has no amount before the trade.

In other words, the amount required as a good faith deposit to hold opened position is called margin. It is expressed in the percentage. For example, if the broker provides a 1.00% margin (which is equal to 1:100 leverage) then you can trade $200,000 with $2,000.

Few terms used in the margin are given below:

Margin Requirement:

We have discussed in the above section, the amount of money required to hold a trade position.  

Account Balance:

The total amount of money in your trading account is your account balance.

Margin Call:

You get this when the amount of money on your account cannot cover your possible loss. It happens when your fairness falls below your used margin. In case of a margin call, all opened positions will be closed at the current market value by your broker.

Usable Margin:

The quantity of your account balance which is available for open new trading positions.

Used Margin:

The locked amount of money used to hold your current trading position. You cannot use your money until you close the current trading position either you receive a margin call or when your broker gives it back.

In other words, the Used Margin is the amount of account equity currently committed to maintaining open positions.

  1. Used Margin can be thought as the trader’s ‘good faith’ deposit on the open positions
  2. The account must maintain AT LEAST this amount for open trades to remain open

Brokers use margin levels in an attempt to detect whether FX traders can take any new positions or not. Different brokers have varying limits for the margin level, but most will set this limit at 100%. This limit is called a margin call level.

Define The Lot With Lot Sizes:

The lot is a standard used to specify your trade size or volume in the forex market.
The standard size of lot size is 100,000 units of your base currency. There are also mini, micro and nano lot size available in the market. Mini, micro and nano lot sizes contain 10,000, 1,000, and 100 units.

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