Now you might be wondering how it is possible to earn big money trading the Forex? The answer is Margin trading. In other words you trade with borrowed money.
Forex is always traded in Lots, so in actual fact you can not purchase just 100 Euros, (or in fact 100 units of any currency). A standard Lot is $ 100,000, some brokers offer Mini-Lots of $ 10,000, and a few brokers also offer Micro-Lots of $ 1,000. The good news is you do not need anything like $ 100,000 to open a Forex account or to trade the Forex.
The Forex market uses a system called Margin trading, where you pay the broker a security margin, usually between 0.25 and 5 percent. The security margin gives you control over a very much larger unit (or lot) of currency. For example, to trade a standard lot $ 100,000, your broker will probably require a margin (deposit) of 1 percent = $ 1,000. (In actual fact you will need more than $ 1,000 in your account, in case the market moves against you.
Suppose you sell $ 100,000 and buy Euros at 10:00 AM. The Euros will cost $ 1.4725 each. So you will receive (rounded) 67912 EUR. Your 67912 EUR will have a value of 67912 x 1.4720 = $ 99,967 (Note: You have lost $ 33 instantly because of the bid / ask spread.) Now, suppose you sell your Euros at 5 PM and close the trade. You sell your 67912 EUR and buy US dollars. You receive $ 1.4770 for each Euro = 67912 x 1.4770 = $ 100,306. So you make an overall profit of $ 306 on the days trading.
Margin trading is an example of leverage (sometimes called geared), where you are using a relatively small amount of money to control (or lever) a very much larger amount of money. This enables you to profit (or lose) from very small changes in Forex quotes.
If you trade with $ 1,000, you will need more than $ 1,000 in your account. In the example above, if you only had $ 1,000 in your account to start, you would have a negative amount (- $ 33) in your account immediately after your trade was opened.
Now, suppose you started with $ 2,000 in your account:
You sell US $ 100,000 and buy Euros at 10:00 AM. Your used margin is now $ 1,033, so the usable margin in your account is $ 2,000 – $ 1,033 = $ 967. Imagine the trade moves against you, so that at 12:14 PM the Forex quote: EUR / USD = 1.4578 / 1.4583. Your 67912 EUR are now worth 67912 x 1.4578 = $ 99,002, and the usable margin in your account = $ 2,000 – $ 1,998 = $ 2. This would result in a margin call, and your trade would be closed to prevent your account going negative, so you would lose $ 1,998.
If however, you had $ 3,000 in your account, your trade could have continued:
If the trade had continued moving against you so at at 1:00 PM the Forex quote: EUR / USD = 1.4570 / 1.4575. Your 67912 EUR are now worth 67912 x 1.4570 = $ 98,948. Your used margin is now $ 2,052 but you still have $ 3,000 – $ 2,052 = $ 948 in your account, so you can continue trading. If the Euro then recovers, so that at 5:00 PM the forex quote: EUR / USD = 1.4770 / 1.4775, you sell your 67912 EUR at $ 1.4770 each and make an overall profit of $ 306.
Always aim to have at least twice your margin in your account at all times (even when a trade moves against you). However, it is safer still if you never trade with more than 10 percent of your account at any time.
Margin Percent = 100 / Leverage
Leverage = 100 / Margin Percent