These days Forex trading has become one of the most looked after occupation for many persons around the world. This great interest in Forex trading is due to its great advantages over other capital markets and its high potential profitability; among these advantages we can find its extremely easy accessibility thanks to the widespread presence of internet connections, the high liquidity of the market and maybe the most important characteristic of this market, its high leverage.
It is very usual to find that many beginning traders don't fully understand the basic concept of leverage. Basically, if you have a start up capital of $5,000 and if you trade on a 1:50 margin you can effectively control a capital of $250,000. However, a two percent move against you and your capital will be completely wiped out. So a good advice is that if you are a new trader you should not use more than 1:20 margin until you get comfortable and profitable with your trading and then and only then you can attempt to use higher margins.
What does 1:20 margin mean? It means that with your $5,000 you will control a capital of $100,000. For example, let's say you are trading EUR/USD and by using a given entry strategy you have decided to enter the trade on a long side. That means that you are betting that USD will depreciate against Euro. In other words, the Euro will increase in value.
Let's say current EUR/USD rate is 1.305. So, if your trading capital is $5,000 and you are using 1:20 leverage you will effectively be exchanging $100,000 to Euros. If the current rate is 1.305 you will receive 100,000/1.305 = 76,628 Euros.
If the trade goes in your direction margin will work in your favor and 1% decline in USD will mean 20% increase in your start up capital. So if EUR/USD rate moves from 1.305 to 1.318 you will be able to exchange your 76, 628 Euros back to $101,000 for a profit of $1,000. Since your start up capital was $5,000 it is effectively a 20% increase in your account. However, if the trade went against you and USD appreciated 1% vs. Euro your account would be reduced to $4,000.
In Forex as in all other speculative activities in the capital markets there is a major problem, as you can see from the last example, new and experienced traders will face every time they open their forex trading stations. This is how to predict the behavior of the Forex market over time in order to make the highest amount of profits and with the less risk possible.
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