Trading on a margined basis in foreign exchange is not a complicated concept as some may make it out to be. The easiest way to view margin trading is like this:
Essentially when a trader trades on margin he is using a free short-term credit allowance from the institution that is offering the margin. This short-term credit allowance is used to purchase an amount of currency that greatly exceeds the account value of the trader. Let's take the following example:
Example: Trader X
has an account with EUR 50'000 with ACM. He trades ticket sizes of 1'000'000
EUR/USD. This equates to a margin ratio of 5% (50'000 is 5% of 1'000'000).
How can trader x trade 20 times the amount of money he has at his disposal?
The answer is that he temporarily receives the necessary credit to make
the transaction he is interested in making. Without margin, trader X would
only be able to buy or sell tickets of 50'000 at a time.
Margin serves as collateral to cover any losses that you might incur. Since nothing is actually being purchased or sold for delivery, the only requirement, and indeed the only real purpose for having funds in your account, is for sufficient margin.
We do not recommend
trading with full 1% margin capacity as this engages a large amount of
risk. Ultimately the choice is left to the trader to make transactions
that meet his appetite for risk.
Recommended further reading:
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