Most forex trading firms will offer leverage of up to 100 to 1 or more, which requires traders to put up only $1000 in margin for every $100,000 in positions traded. If fully used this would take a 1% move in a currency pair and turn that move into a 100% gain or loss on the value of your account.
The easiest way to understand this is by seeing it in real time by logging into our real time demo trading accounts. If you have not done so already I encourage you to register for a free demo dailyfx.com.
Once logged into the platform, in the upper right hand corner of the platform you should see a window that says “Accounts”. In this window from right to left you should see the following columns:
1. The Accounts Column: This lists your account number and if you were trading multiple accounts the other accounts you were trading would be listed here as well.
2. The Balance Column: This lists the amount of money in your account not including any profit or loss on open positions.
3. The Equity Column: This lists the amount of money in your account including any profit or loss on open positions.
4. Day P/L: This is the gain or loss on any open positions for the trading day which begins and ends at 5pm Eastern Standard Time on this particular platform.
4. The Margin Column: This stands for Used Margin and is the amount of money in your account which has been allocated for margining your open positions. If you have no open positions this column will read zero so go ahead and click on the dealing rates window and open a 1 contract position. If you have multiple positions open go ahead and close out the additional positions by clicking on the close rate in the close column beside those positions so that you have only 1 position open.
Once you do this you should see the amount in the Margin column at $1000. We are trading a contract size of 100,000 of the base currency, which puts the leverage which has been extended to us on this particular demo account at exactly 100 to 1 for currency pairs in which the US Dollar is the base currency and somewhere near 100 to 1 for currency pairs in which it is not.
Another way of looking at this is that the Usable Margin Column is the Equity Column minus the used margin Column.
If the number in this column drops to zero then the trading platform will automatically generate a margin call and close the open positions on your account. With this in mind, it is important to always have a clear understanding of how much money you need in your account to open each new position so you do not over leverage yourself or worse end up in a margin call situation.
We are going to get into more in depth examples in our next lesson but to quickly demonstrate the relationship between the used margin and usable margin columns lets left click in the dealing rates window and open a 2 lot position of EUR/USD, which will bring the total in our account to 3 open contracts.
Once that position is open the number in your Used Margin column should have gone up by $2000 to account for the two additional contracts we just opened, and the amount in the usable margin column should have gone down by $2000.
Not respecting the amount of leverage offered in the forex market is probably the number 1 reason why many traders not only fail when trying to trade the forex market but loose their entire account balance. While the market is not a volatile market in and of itself, you can turn it into a highly volatile instrument by upping the amount of leverage used, which puts your account balance at risk.