A pip isn’t very much in dollars and cents – even if you make a profit of 30 pips on a trade… that still isn’t much profit, as it stands.

To take advantage of these tiny increments, you need to trade large amounts of a currency in order to see any significant profit – or loss. This is where leverage comes in, and with leverage comes margin.

Let’s say you open a micro account with a forex broker, using $1,000.
This $1,000 is known as the account margin or initial margin.

So you’re going to make a trade, for example using $100, 10% of your account (this would most likely be too much, in the real world).

What your broker does is offer to leverage $100 of yours into $10,000 to go into the market. This would be a leverage of 100:1 They can do this because the price is never going to go suddenly to zero – you’d always be able to sell back at something close in absolute terms to what you bought at – in relative terms, maybe not so close..

In return, your dealer sets a margin. Margin trading allows a trader to hold a position much larger than the actual account value – although the trade might only involve $100, the other $900 is acting as a deposit against the notional value of your position, $10,000.

Margin percentage = 100 / Leverage

So a 1% margin is equivalent to 100:1 leverage – you’ll see various figures for leverages/margins quoted by various brokers for different types of account. Like most things in life, the more money you’re putting their way, the more flexible your options magically become.

With leverage, the whole account is in play. Your usable margin, here $900, is the money available to open new positions or sustain trading losses, that is, money you haven’t committed to a trade. And so with margins come margin calls.

The Margin Call

Maybe things haven’t gone well, just for once. You’ve made your $100 trade and the price has gone the wrong way for you. While you leave the trade open (hoping that the price is going to reverse and start going your way…) the leveraged $10,000 stake is starting to eat into your usable margin.

If the price carries on going the wrong way, at some point you’ll have no usable margin left to cover your losses – so the broker will step in with a margin call – the trade is closed whether you like it or not, and whether or not the price suddenly starts going your way a minute later.

It’s vital therefore, when operating a forex account, that you have sufficient capital in there to cope with a price that might have a short-term blip the wrong way for you and wipe out that trade – you always need the buffer of capital behind you, when working with leverage.

(Margin calls close all open positions at the time – not just enough to get you back in the black – this is almost universal practice with online trading now).

But it’s not all bad…

Obviously, you will have realised that trading with leverage is double-edged. Use it sensibly, no problem… use it unwisely – and the #1 problem for forex beginners is going in undercapitalized and therefore needing/being tempted to use high leverages – big problem…

So why use it? Because, as we said at the begining, it would take forever to make or lose any real money – unless you’re starting off with a million….

But which?
Up to now, we’ve been talking about buying or selling, going long or short on a currency pair – but how do you know which way to go? That’s a reasonably huge question, and we’ll make a start on it next with candlestick charts…

Go to 4. Candlestick Charts →