In our last lesson we went over the concept of leverage and how the use of leverage in trading can be used to amplify both gains and losses on ones trading account. In today's lesson we are going to continue our free forex trading course with a look at the mechanics of using leverage in the forex market.
As we discussed in our last lesson many people put down 20% in cash to obtain their mortgage, which puts their leverage at 5 to 1. The 20% down payment that many home buyers put down to obtain their mortgage is the equivalent to the margin that a trader puts up to purchase a financial instrument such as a currency pair when trading on margin.
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 using the link above this video if you are watching on InformedTrades.com or to the right of this video if you are watching on Youtube.
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 Usd Mr 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 Usd Margin column at $1000. If you remember from our previous lessons 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.
5. In the next column over you should see a column that says Usbl Mr. This is the amount of money that you have in your account including any profit or loss on open positions, that is over and above the money allocated to margin any open positions in the account.
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.
As we discussed in our last lesson, 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 and therefore trading career at risk.
Thats our lesson for today, in our next lesson we will look at several examples of leverage at work on our forex trading demo accounts so we can start to get a feel for what an appropriate amount of leverage may be so we hope to see you in that lesson.
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Risk Disclosure: Trading forex on margin carries a high level of risk, and may not be suitable for all investors. The high degree of leverage can work against you as well as for you. Before deciding to invest in foreign exchange you should carefully consider your investment objectives, level of experience, and risk appetite. The possibility exists that you could sustain a loss of some or all of your initial investment and therefore you should not invest money that you cannot afford to lose. You should be aware of all the risks associated with foreign exchange trading, and seek advice from an independent financial advisor if you have any doubts.