One feature that attracts investors to spot currency trading or retail spot forex is that it is done through a margin trading system that allows investors to maximize the returns for their investments. For example, under the margin trading system, a trader with just $5,000 deposited in his account can buy or sell up to $500,000 of currency contracts. Let us examine how this is possible. According to “Wikipedia, “a margin is collateral that the holder of a position in securities, options, or futures contracts has to deposit to cover the credit risk of his counterparty (often his broker) with a demat account in India.
In online spot currency trading, currencies are bought and sold in tranches or by lots of $100,000 each. When a trader opens an account with a broker, his initial margin deposit serves as collateral to cover future losses that the trader may incur during his trading activities. In exchange for the margin deposit, the broker extends a credit line to the trader equivalent to 100 times his margin deposit (200x for other brokers). The trader can trade up to 5 lots or $500,000 worth of currencies. Profits and losses are computed based on the number of lots the trader has bought or sold with margin trading.
Now, here is what every trader must understand clearly (the complications). As the prices start to go against you, the value of the contracts you hold will depreciate, similar to our computation above. More importantly, your margin deposit will also decline in equivalent value. Most online brokers follow the general practice of setting a cut point (called a margin call point officially) up to which point losses in your account will be tolerated. This cut point is generally set at 25% of the required margin for the number of lots traded. Once this cut point is reached or breached, your open positions and your trades will be automatically cut off at a loss without any notification from your broker; even if the rates return favorably after that with the idea of margin trading.
To take, for example, you can seek the example above; since we bought one lot, our required margin is $1,000; 25% of this is $250. As the prices continue to go against you, your margin decreases and if it continues to decrease in value and reaches the point where your remaining margin ( your required margin of $1,000 less your floating loss) is $250, the broker will, without notice whatsoever, liquidate your position automatically. This is the general practice being followed everywhere and was designed to keep the foreign currency market efficient. Without this, a trader may stand to lose more than what he has deposited and the broker may have to face the burden of collecting from losing traders using a best demat account in India.
Knowing the implication of your margin deposit to your trading activities and having the knowledge to compute where your cut-points would be every time you initiate a trade is essential to trading foreign currencies successfully. It will give a clearer picture of which work to take and the financial implications of the risk your take in every trading opportunity you are about to take before you take them with margin trading.