FOREX Margin
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Forex is a nickname for the
foreign exchange, a vast market of trading in which the
commodity is money itself. In the forex market, traders are
buying and selling foreign currencies -- trading dollars for
euros, pounds for yen, and so forth.
Forex is profitable because
national currencies fluctuate from day to day based on
predictions of the nation’s gross domestic product and other
factors. As with the stock market, the idea with the forex
is to buy low and sell high: Buy a lot of a particular
currency when it’s weak, then sell it when it becomes
stronger.
For example, bad financial news
in Great Britain means that forex traders will be selling
off their British pounds as fast as possible, as the pound
is about to become devalued. Once the pound recovers, those
traders will sell it for something else, thus turning a
profit.
Though we talk of “buying” and
“selling” pounds, euros, yen and francs, the transactions
performed in the forex are not literal. That is, if you want
to buy 100,000 euros, you don’t have to withdraw the
equivalent U.S. dollars from your bank account and swap them
out for a big stack of euros. Everything is done on paper
only, though the resulting profits and losses are real.
Because the transactions are
not done physically, there is room in the forex for what are
called “margins” or “leverage.” Put simply, this means you
don’t have to actually put up the full amount of the
position you’re taking. Usually the margin is 1%, meaning
that when you put $1,000 into it, you’re actually getting
$100,000. Of course, margins multiply your losses as well as
your profits, so you have to be careful.
One of the reasons for allowing
a 100:1 margin like this is that the major world currencies
in the forex market usually fluctuate less than 1% a day.
(In the stock market, a typical stock might fluctuate as
much as 10% in one day.) With changes that small, your daily
loss or gain on an initial investment of $1,000 would be
almost imperceptible, usually less than $10 either way. By
multiplying it by 100, the gains and losses in the forex
market are more pronounced.
With leverage implemented that
way, the basic “lot” for buying and selling currencies is
usually 100,000 (which of course only costs 1,000). Most
firms that handle day-trading on the forex market don’t go
any lower than that.
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