In this video you'll learn how margin workswhen trading currencies, the benefits and risks of trading on margin, and how it canaffect your trades.
Let's start by looking at the units currenciesare traded in.
Most currencies are traded in lots.
The lot sizes vary depending on the amountof money an investor wants to devote to a position.
A standard lot represents 100,000 units ofa currency, mini lots represent 10,000 units, and micro lots represent 1,000 units.
When trading currencies, you're dealingwith pips.
A pip is a percentage of a point that actuallyextends four decimal places.
This means you're commonly dealing with100ths of a penny.
However, when trading Yen (JPY), a pip onlyextends to the second decimal, 0.
Depending on the currency pair, A 100th ofa penny with 100,000 units means each pip is worth about $10.
For example, let's say the exchange ratefor euros to U.
dollars is a ratio of 1.
In this case, 100,000 units mean that 100,000euros is the same as $140,000 U.
Investing $140,000 may be difficult for sometraders, which is where margin comes in.
When purchasing a lot in the forex market,you're actually placing a good faith deposit known as a performance bond but commonly calledmargin.
If you're familiar with margin in stocks,margin in the forex market is not much different.
When trading stock, the margin requirementis the amount of capital needed to enter into a position.
The same is true for currencies.
Margin in the forex market is simply the amountof capital you need to open a position in a currency pair.
Trading on margin creates leverage which canresult in significant gains as well as significant losses.
Forex can be split into two different categories:major pairs and minor pairs.
Major pairs, such as the US dollar, euro,and yen are more commonly traded and the margin requirement can be as low as 2%, which resultsin 50 to 1 leverage.
So, for every dollar you have on margin, youcontrol about $50 in a trade.
As we stated earlier, this 50 to 1 leverageapplies to certain major pairs, but minor pairs like the Mexican peso, Singapore dollarand Hong Kong dollar are commonly 20 to 1.
These ratios can change, so talk with theForex Trade Desk to be sure you understand the leverage you're dealing with.
Let's go back to our example where 100,000euros equaled $140,000.
How much would you need on margin to tradethis pair? Well, a 2% margin requirement is simply 2%of the total unit value.
Therefore, your margin requirement would be$2,800.
On pairs where the U.
dollar is not included,the total unit amount will have to be converted to U.
If you think about it, $2,800 isn't a lotof money to control $140,000.
This means it wouldn't take much for thepair to move against you and eat up your initial margin.
Let's look at an example of this type ofleverage.
Remember that when trading standard lots of100,000 units each pip movement equals about $10.
Therefore, a pair that increases 90 pips couldresult in a $900 profit.
Of course, the opposite is also true; a decreaseof 90 pips could result in a $900 loss.
The leverage gained through margin is oneof the biggest reasons traders trade the forex market.
However, this is also why smaller lots maybe preferable.
Trading mini- or micro-lots might be moresuitable for your trading goals and risk tolerance.
Mini-lots represent 10,000 units with a pipvalue of around $1 and a micro-lots represent only 1,000 units with each pip worth about10 cents.
While these forex trades can be rewarding,there is also some risk because of the leverage.
So you should always have a well-definedplan when you're dealing with margin that determines a clear exit.
This way, if a trade doesn't work the wayyou expect, you can limit the losses.