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Forex Basics
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Leverage
Leverage
One key aspect of forex trading is the leverage involved. Many forex dealers offer 100:1* leverage, some dealers offer leverage as high as 400:1. What this means is that for every dollar you put in you are actually controlling $100 dollars worth of currency.
Currency pairs are traded in lots and the lots allow for you to take leveraged positions to speculate on the value of various currency pairs. There are typically 3 types of lots; standard lots, mini lots and micro lots.
With a standard lot you are taking on a position where every pip is roughly $10, with a mini lot every pip is roughly $1 and with a micro every pip is roughly 10 cents.
If your account is denominated in US Dollars then the dollar amount to acquire 100,000 units of the base (top) currency is put up as margin for each standard lot you trade. Minis and micros decrease by a factor of 10 respectively. This is actually a lot simpler than it sounds. For example if the rate on the EUR/USD is 1.5595 you would be putting up $1559.50 margin to control 100,000 Euros.
Let's go through a hypothetical EUR/USD trade with the two currency quotes below so you can follow along. We purposely used 2 different color quotes so that we can distinguish between the 2.
Let's assume that you have $5,000 in your account and you see a buying opportunity in the EUR/USD. At the time of the opportunity the EUR/USD pair is trading at 1.2635 bid by 1.2638 ask (white quote below). So you decide to place a trade with 1 mini lot to go long the EUR/USD pair.
In order to do this you will be buying at the ask price which is 1.2638. So basically for 1 mini lot you will be purchasing 10,000 Euros and borrowing $12,638. So since you have 100:1* leverage you will be putting up $126.38 in margin for this position. Since you are trading with a mini lot every tick (pip) will be worth roughly $1 on this position.
Now let's say that over time you were correct and the EUR/USD pair did appreciate in value. And the new price is 1.3073 bid by 1.3074 ask (as depicted in the black quote). You decide to sell. So you sell to close out your position. So you sell at the bid which is 1.3073. This means that you just locked in a 435 pip profit. Since you traded 1 mini lot each pip was worth $1 so you receive $435 dollars in profit. And now your account will have $5,435 in it.
Assume the same example above, but say, this time, you were incorrect over time and the EUR/USD pair did not appreciate in value. The new price is actually 1.2228 bid by 1.2229 ask. You decide to sell. You sell to close out your position. You sell at the bid, which is 1.1828. This means that you just took on a 410 pip loss. Since you traded 1 mini lot each pip was worth $1, so you suffer $410 dollars in loss. Now your account will have $4,590 in it.
Hopefully this example simplified the process for you. We have many more in depth detailed examples in our education section for you to look at. To clarify the concept.
Forex trading involves significant risk of loss and is not suitable for all investors. While you can earn a cash bonus,
you can also lose money due to the inherent risk of trading. Read full disclosure.
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