Using margin in Forex trading is a new concept for many traders, and one that is often misunderstood. Margin is a good faith deposit that a trader puts up for collateral to hold open a position.
More often than not margin gets confused as a fee to a trader. It is actually not a transaction cost, but a portion of your account equity set aside and allocated as a margin deposit.
When trading with margin it is important to remember that the amount of margin needed to hold open a position will ultimately be determined by trade size. As trade size increases your margin requirement will increase as well. Leverage is a byproduct of margin and allows an individual to control larger trade sizes. Traders will use this tool as a way to magnify their returns. Therefore, it is important to understand that leverage needs to be controlled.
Using leverages can have extreme effects on your accounts if it is not used properly. Trading larger lot sizes through leverage can ratchet up your gains, but ultimately can lead to larger losses if a trade moves against you. Below we can see this concept in action by viewing a hypothetical trading scenario. Trader A used his account to lever his account up to a , notional position using 50 to 1 leverage. Trader B traded a more conservative 5 to 1 leverage taking a notional position of 50, So what are the results on each traders balance after a pip stop loss?
Trader B on the other hand fared much better. Through leverage management Trader B can continue to trade and potentially take advantage of future winning moves. Typically traders have a greater chance of long-term success when using a conservative amount of leverage.
Keep this information in mind when looking to trade your next position and keep effective leverage of 10 to 1 or less to maximize your trading. Interested in learning more about Forex trading and strategy development? Register here to continue your Forex learning now!
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