Forex margin trading is a way of using leverage to multiply the purchasing power of your account equity. Leverage simply means using a small sum to control a much larger amount. This is viable because it is unlikely that the price of a currency will move by more than some percentage points within a short time. So you could place a few hundred dollars in your brokerage account to trade on the margin - the amount that you think the price could change. Your broker will practically lend you the balance.

Trading on margins is also known in stock and commodities trading, but due to the special nature of currencies, you may get a lot more leverage in the foreign exchange markets. Depending on your broker's terms, you could be able to control 50, 100 or even 200 times your account balance.

This can produce great gains if you are successful, but it can also mean big losses if not. Usually, the higher leverage you use, the more risky your trading is.

We can understand leverage and margins if we consider an example.

Imagine that the current rate on the British pound to US dollar currency market is shown as GBP/USD 1.7100. So to purchase one British pound you would need $1.71. If you predicted the value of the dollar to go up against the pound you may decide to sell enough pounds to buy $100,000. If your broker used lots of $10,000 each, this would be 10 lots. Then you would sit back and wait for the price to move up.

A few days later you might find that the price had moved to GBP/USD 1.6600. Sure enough, the dollar has risen and the pound is now worth only $1.66. If you sell your dollars now and buy back into pounds, you will have made a profit of 2.9% less the spread. 2.9% of $100,000 is $2,900, so that would be an outstanding trade.

But most individuals do not have $100,000 spare cash that we can use to trade on the currency exchange markets. So here is where the principle of margin trading comes into play.

Because you are buying and selling different currencies at the same time, your own cash just has to cover any loss that you will probably make if the dollar falls instead of rising. And you would use a stop loss to limit that loss, so $1,000 could be all you needed to have in your account to make this $100,000 purchase. Your broker guarantees the other $99,000.

In fact most brokers now operate limited risk amounts where the system will automatically close out the trade if whatever funds you have in your account are lost. This prevents margin calls which can be disastrous for a trader because they mean that you can lose more than you have. But with a forex limited risk account that is impossible. The broker's platform that you use to control your account will not let you lose more than your margin equity.

Using leverage in this way is so common in currency trading that you will soon do it without even thinking about it. Still it is important to bear in mind the risks. Lower leverage is invariably safer and you may never want to go to the maximum forex margin that your broker would allow. You can also reduce your risk by using highly reliable forex signals. There are many forex signal providers available online. But keep in mind the fact, that not all forex signals are winners, so don't bet too much on any single position.

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