Foreign Exchange Market (Forex) essentially trades currencies. The purpose of Forex is to facilitate international trade through simplified financial transactions. Forex helps the traders purchase or sell their commodities without affecting the currency being traded in and the countries involved. It is one of the largest markets in the world and highest in terms of liquidity as well. Forex is closely associated with the functioning of Margins and Leverage.
Margin is the minimum amount of capital that must be available in a trading account to trade a particular market. Market providers require collateral to ensure that the investor can pay in case of losses. This sum is called margin and is also the minimum security in Forex. Margin is basically the deposit to the trader account intended to cover possible trading losses.
How is Margin Set?
Margin varies from one market to another based on the volatility of the market. For most day trading markets, the margin amount is set by the exchange that provides the market, but for Forex markets, the margin amount is set by the brokerage.
How is Margin used?
While the trade is active, the margin remains unavailable since it is being used. When it is inactive, complete amount of its margin will be available for trading. When the trader enters a new trade, the margin is decreased as required. When the trader exits the trade, the margin becomes available again, and can be used for a new trade on same or other market. If there is a drop in the trading account below the margin amount, the trader will be prevented from entering any trade until the balance is recovered.
Leverage is the minimum percentage of amount intended for trade required to begin with. Margin is the minimum amount of cash needed to be allowed to trade using leverage. Trading using leverage is trading on credit, with lesser deposit followed by borrowing a larger amount of cash. For example, if a trade requires a margin of $10,000, it can be bought with only $3,000 using leverage.
Advantages of using Leverage
Though the use of Leverage is risky, it enjoys certain advantages. Leverage allows traders to trade markets that would otherwise not be available. It also allows traders to trade more contracts than otherwise affordable.