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The loan (leverage) in the margined
account is collateralized by your initial margin
(deposit), if the value of the trade (position)
drops sufficiently, the broker will ask you to either
put in more cash, or sell a portion of your position
or even close your position.
Margin rules may be regulated in some
countries, but margin requirements and interest
vary among broker/dealers so always check with the
company you are dealing with to ensure you understand
their policy.
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Up until this point you are probably
wondering how a small investor can trade such large
amounts of money (positions). The amount of leverage
you use will depend on your broker and what you
feel comfortable with. There was a time when it
was difficult to find companies prepared to offer
margined accounts but nowadays you can get leverage
from a high as 1% with some brokers. This means
you could control $100,000 with only $1,000.
Typically the broker will have a minimum
account size also known as account margin or initial
margin e.g. $10,000. Once you have deposited your
money you will then be able to trade. The broker
will also stipulate how much they require per position
(lot) traded.
In the example above for every $1,000
you have you can take a lot of $100,000 so if you
have $5,000 they may allow you to trade up to $500,00
of forex.
The minimum security (Margin) for
each lot will very from broker to broker. In the
example above the broker required a one percent
margin. This means that for every $100,000 traded
the broker wanted $1,000 as security on the position.
Margin call is also something that
you will have to be aware of. If for any reason
the broker thinks that your position is in danger
e.g. you have a position of $100,000 with a margin
of one percent ($1,000) and your losses are approaching
your margin ($1,000). He will call you and either
ask you to deposit more money, or close your position
to limit your risk and his risk.
If you are going to trade on a margin
account it is imperative that you talk with your
broker first to find out what their polices are
on this type of accounts.
Variation Margin is also very important.
Variation margin is the amount of profit or loss
your account is showing on open positions.
Let's say you have just deposited
$10,000 with your broker. You take 5 lots of USD/JPY,
which is $500,000. To secure this the broker needs
$5,000 (1%).
The trade goes bad and your losses
equal $5001, your broker may do a margin call. The
reason he may do a margin call is that even though
you still have $4,999 in your account the broker
needs that as security and allowing you to use it
could endanger yourself and him.
Another way to look at it is this,
if you have an account of $10,000 and you have a
1 lot ($100,000) position.
That's $1,000 assuming
a (1% margin) is no longer available for you to
trade. The money still belongs to you but for the
time you are margined the broker needs that as security.
Another point of note is that some
brokers may require a higher margin during the weekends.
This may take the form of 1% margin during the week
and if you intend to hold the position over the
weekend it may rise to 2% or higher. Also in the
example we have used a 1% margin.
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This is by no
means standard. I have seen as high as 0.5% and
many between 3%-5% margin. It all depends on your
broker.
There have been many discussions on
the topic of margin and some argue that too much
margin is dangerous. This is a point for the individual
concerned. The important thing to remember as with
all trading is that you thoroughly understand your
broker's policies on the subject and you are comfortable
with and understand your risk.
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