FOREX Description

Margin Trading

Unlike currency transactions with actual delivery or real currency exchange, FOREX participants (especially the ones with limited funds) use an insurance deposit trade called marginal trade or leverage trade. In the case of marginal trade, each transaction must consist of two steps: purchase (sale) of currency at a price and then obligatory sale (purchase) at another (or the same) price. The first action is called position opening and the second one is called position closing. When opening a position, there is no actual currency delivery and the participant who is opening the position deposits a collateral, which is a security against possible losses. After the closing of the position the insurance deposit is paid back and losses or profits are calculated. They are usually similar in size to the insurance deposit. At that, the deposit is often 1/100 or 1/200 of the sum that the participant is entitled to use in this trade transaction.

A marginal trade transaction always consists of two parts: position opening and position closing. For instance, while foreseeing a rise (strengthening) of the yen against the dollar, we want to buy the cheaper yen for dollars now and sell it back when it rises. In this case, the transaction will look like this: position opening is the yen purchase and position closing is the yen sale. All the time until the position is closed, we have a 'yen open position'. Similarly, if we believe that the yen is going to fall (turn weak) against the dollar, our transactions will consist of the following stages: position opening that is the sale of the expensive yen and then position closing that is the purchase of the cheaper yen. In this way, we are able to make profit when the currency rate goes both down and up.

For example, to carry out a $100,000 deal with a 1% margin (leverage rate is 1:100), it is necessary to pay in just $1,000 as a collateral. As a result, even if you have only relatively limited funds, you are able to operate market sums of hundreds of thousands dollars. Let us suppose that you have US$1,000 in your account which entitles you to make a market lot deal of $100,000. Suppose that after analyzing the change in the USD/JPY rate, you make a decision to sell US$100,000 against the Japanese yen at the price of 124.80. In several hours, when the USD/JPY rate falls by 100 points and reaches 123.80, you decide to close the position and buy dollars cheaper than you sold, and therefore make a profit.

Profit = [(closing rate - opening rate)*deal amount] / closing rate

Profit = [(124.80 - 123.80) * 100,000] / 123.80 = 807.75 USD