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Understanding
Margin
Trading currencies on margin lets you increase your buying
power. Here's a simplified example: If you have $2,000
cash in a margin account that allows 100:1 leverage, you
could purchase up to $200,000 worth of currency-because
you only have to post 1% of the purchase price as collateral.
Another way of saying this is that you have $200,000 in
buying power.
Benefits of Margin
With more buying power, you can increase your total return
on investment with less cash outlay. To be sure, trading
on margin magnifies your profits AND your losses.
Here's a hypothetical example that demonstrates the upside
of trading on margin:
With a US$5,000 balance in your margin account, you decide
that the US Dollar (USD) is undervalued against the Swiss
Franc (CHF).
To execute this strategy, you must buy Dollars (simultaneously
selling Francs), and then wait for the exchange rate to
rise.
The current bid/ask price for USD/CHF is 1.6322/1.6327
(meaning you can buy $1 US for 1.6327 Swiss Francs or
sell $1 US for 1.6322)
Your available leverage is 100:1 or 1%. You execute the
trade, buying a one lot: buying 100,000 US dollars and
selling 163,270 Swiss Francs.
At 100:1 leverage, your initial margin deposit for this
trade is $1,000. Your account balance is now $4000.
As you expected, USD/CHF rises to 1.6435/40. You can now
sell $1 US for 1.6435 Francs or buy $1 US for 1.6440 Francs.
Since you're long dollars (and are short francs), you
must now sell dollars and buy back the francs to realize
any profit.
You close out the position, selling one lot (selling 100,000
US dollar and receiving 164,350 CHF) Since you originally
sold (paid) 163,270 CHF, your profit is 1080 CHF.
To calculate your P&L in terms of US dollars, simply
divide 1080 by the current USD/CHF rate of 1.6435. Your
profit on this trade is $657.13
SUMMARY
Initial Investment: $1000
Profit: $657.13
Return on investment: 65.7%
If you had executed this trade without using leverage,
your return on investment would be less than 1%.
Managing a Margin Account
Trading on margin can be a profitable investment strategy,
but it's important that you take the time to understand
the risks.
• You should make sure you fully understand how
your margin account works. Be sure to read the margin
agreement between you and your clearing firm. Talk to
your account representative if you have any questions.
• The positions in your account could be partially
or totally liquidated should the available margin in
your account fall below a predetermined threshold.
• You may not receive a margin call before your
positions are liquidated.
You should monitor your margin balance on a regular
basis and utilize stop-loss orders on every open position
to limit downside risk.
For information on managing margin in your InterBank
Group account, click here.
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