Introduction to Forex - Understanding Margins

Trading on a margined basis in foreign exchange is not a complicated concept as some may make it out to be. The easiest way to view margin trading is like this:

Essentially when a trader trades on margin he is using a free short-term credit allowance from the institution that is offering the margin. This short-term credit allowance is used to purchase an amount of currency that greatly exceeds the account value of the trader. Let's take the following example:

Example: Trader x has an account with EUR 50'00. He trades ticket sizes of 100'000 EUR/USD. This equates to a margin ratio of 2% (2’000 is 2% of 100'000). How can trader x trade 50 times the amount of money he has at his disposal? The answer is that the OFB temporarily gives the necessary credit to make the transaction s/he is interested in making. Without margin, trader x would only be able to buy or sell tickets of 2’000 at a time. On standard accounts OFB applies a minimum 2% margin.

Margin serves as collateral to cover any losses that you might incur. Since nothing is actually being purchased or sold for delivery, the only requirement, and indeed the only real purpose for having funds in your account, is for sufficient margin.

An Example

A Foreign exchange quote , e.g. EUR/USD "1.2700 /03" represents the bid / offer spread in this case for EUR / USD. The rate of 1.2703 is the rate at which you can Buy EUR against the US Dollar. The rate of 1.2700 is the rate at which you can Sell EUR against the US Dollar.

Opening Trade

Price Shown	1.2700 Bid  / 03 Offer
Sell Price	1.2703
Quantity size	100,000
Margin Required (2%)	100,000 x 1.2703 x 2% = $2,540.6
Commission	$20.00

The Euro appreciates against the US Dollar and the client wishes to close the position. OFB is now quoting 1.2750 / 1.2753.

Closing Trade

Price Shown	1.2750 Bid  / 1.2753 offer
Buy Price	1.2753
Price/point movement	50 points
Gross profit/loss	50 x $10 = $500.00 profit
Net profit/(loss)	$ 500 – (Commission $ 20) = $480