Forex margin trading has become that very basis that provides many traders with the opportunities to earn money on the international Forex market, stock exchange etc. However, there is a certain difference between the general economic definition of “margin” and “Forex margin”. So, we are going to study this question in this article.
Margin shows profit of a company after all the goods are sold and all the expenses are netted off. Thus, the level of margin can never exceed 100%.
If we talk about international financial markets where foreign currency and securities are traded we should explain what Forex margin is. This term reveals the essence of large international markets as it explains the very scheme of functioning of the “client - broker – international market” chain. This chain appeared on Forex market after margin trading started on stock market and after that on Forex.
How is margin trading fulfilled? In the given case margin is credit funds provided by a broker or dealing center. Thus, we talk about a sort of margin crediting when a trader (the smallest participant) can use large amounts of money borrowed from the dealing center or broker. To use this money the trader provides a certain part of his equity deposit as a security deposit.
The equity deposit is not always money. Everything depends upon the direction of the activity. That is if we talk about Forex margin trading where currency, the most liquid product, is traded the broker will certainly accept only money as a security deposit.
If broker’s client works on the stock market the security deposit will consist of the same financial tools such as shares, bonds and so on.
To sum it up, we can say that margin trading is a financial activity conducted by means of not only one’s own funds, but also credit funds provided the broker.
Margin trading on different financial markets (Forex, stock and other markets) is called a trading with leverage. We distinguish several types of margin operations among which the simplest type is buying at low price in order to sell at high price. Such operation is called “long” or “long position” etc. We single out the following types: bull trading and bear trading.
This operation is more improved and effective way of gaining profit with small deposit based on the presupposition of the price growth. So, traders who want to earn money on the “bullish” market push the price upper and upper as if they raise it on the bull’s horns.
Bear market is Forex margin trading based on the expectations of the currency or share price fall. That is traders who want to earn money on this market push the price down as if bear pins its victim to the ground. Thus, financial markets allow their participants earning money both at the moment of growth and at the moment of decline. That is why traders can use even the economic crisis to gain profit while other companies and the whole economic branches are suffering from losses.
In order to better understand how you can earn on market decline we will take an example of the margin trading at the stock market. The trader sells shares until they have a high price. He does not buy it for his own money. He borrows it from the broker. Then he waits until the price falls down and buys shares back in order to return them to the broker, but at the reduced price. The margin of such operation goes to the trader’s deposit.
Being misled by the bright prospects of Forex and stock margin trading many traders open large trade positions with big lot and high margin level with complete unconcern. So, when the forecast of the situation is made incorrectly and the price goes against the forecast direction the “margin call” takes place after which the broker will have the right to take the decision to close the trader’s trading position independently.
There is a popular misbelief regarding the “margin call”. When it occurs (that is trading account lacks loan funds for the buy / sell order placed at the market) this position is not subject to be closed by the broker. So, when the broker sees that the trader is suffering from big losses he asks the trader to increase the deposit amount in order to cover the margin security deposit. In such a way the broker gives notice of the high risk of the transaction. This margin call being called a warning signal occurs when the trading account reduces by 30%.
As a rule, it is a 10 - 15% reduction that is acceptable on the financial markets.
In cases when the trader gives no feedback to the “margin call” and does not increase the amount up to the 25% of the initial deposit the broker is obliged to close the given trading position without waiting for the result. The dealing center does not take such decision independently. This procedure is stated in the active legislation of nearly all the countries all over the world. That is why no negotiations or requests will help prevent the closure of the transaction.
Why was this state regulation tool created? It was introduced in order to prevent the situation when the trader is indebted to the broker under the circumstances of high price volatility and big losses of clients’ positions. So, under any conditions and whatever high the margin is, when the trader having only one thousand US dollar deposit manages millions, his risk is always limited only with his own deposit. Not more!
Forex margin trading is a professional labour activity regulated by the state laws and containing a pile of preventing rules aimed at managing relations between the trader and the broker. That is the main difference of Forex from the gambling activity which is always compared with Forex by unlucky traders and people who do not understand the basic principles that have become the ground of the single interbank currency market.