Foreign exchange, or forex, is one of the largest traded commodities in the world. This is primarily because any nation that issues currency can feasibly trade in the forex market. It is also due to forex margin. Unlike margin for stock accounts, due to the liquidity of the forex market, brokers give forex traders much higher margin limits. For instance, it is not unusual for a broker to provide a trader with margin of 200 to 1. This means that for every $1 invested in the market, the broker will give you buying power of $200.
Determine the total transaction (notional) value. Let's say you wish to trade one "lot." A lot is 100,000 units in any currency. For instance, the quote 100,000 EUR (euro) / USD (U.S. dollar) is equivalent to 100,000 euros.
Determine the margin requirement. This is the amount of money you are required to put up in order to make a trade, and is referred to as "margin requirement" by the forex broker. Let's say your broker requires 1 percent of the transaction amount before you can trade.
Determine the Forex margin. Multiply the margin requirement by the transaction value. The calculation is 100,000 x 0.01 = $1,000.
Calculate margin-based leverage. Divide total value of the transaction (notional) by the forex margin. The calculation is: 100,000 / 1,000 = 100:1 or 100 to 1.
Margin-based leverage is usually expressed as a ratio. The most common ratios are noted below:
400:1 or 0.25% 200:1 or 0.50% 100:1 or 1.00% 50:1 or 2.00%
When you buy on margin, you're at risk not just for the funds you put up, but for the entire amount of the purchase. In the example above, if you put up $1,000 to purchase a lot of $100,000 worth of Euros, and those Euros drop in value to $90,000, you lose the entire $10,000 drop in value, not just your $1,000. Some currencies are more volatile and significant short-term changes in value are not uncommon. When dealing in forex, you should understand all the related issues thoroughly and work with a trusted professional.
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