When you first get involved in forex trading, there will be a variety of terms that you could come across. One of these terms is “margin”. Far from being intimidating, the margin is simply the amount of money you must contribute to open a new trade (position).
Forex trading typically involves dealing in large amounts of currency in terms of “lots”. 1 standard USD lot, for example, is $100,000. You do not need to put down the whole amount from your own capital, this is where the margin comes into play. Here we will go into more detail about exactly what the margin is, how margin trading within forex works, and some things you should look out for.
Do Forex Brokers Profit from the Margin?
This is a common misconception among some new forex traders. The margin is not a fee of any sort, and the top forex brokers in the industry do not make any kind of profit from the margin in that respect.
All the margin with any forex broker does is to ensure that a certain amount of your own funds are set aside to help cover the cost of any losses you may make on a position you have opened. This margin is effectively the key to enjoying the leverage in forex that your broker provides.
Analyzing the situation on a deeper level, while the forex broker does not directly profit from the margin, they do indirectly benefit from providing you this opportunity to engage in margin trading. This is something we can take a look at in the following section with the provision of some simple to follow examples.
How a Broker Benefits from the Margin
Although not directly profiting from the margin, brokers are able to derive some indirect benefits. The first of these is that simply put, the margin makes it easier for you as a trader to get involved in the forex market. While there are still risks involved of course, the more a broker can encourage you to trade by making it as easy as possible, the more you are likely to engage.
The second key reason that sees brokers garner indirect benefit from the margin is the fact that when you are trading more, and with larger amounts, they can gain additional commissions and perhaps profit from markups on the forex spread and that of other markets beyond forex too which they likely provide trading in.
In summary then, the main benefit for a broker when it comes to the margin in forex is that you will trade more in terms of both frequency and volume.
Knowing and Understanding the Margin Level of Your Broker
As mentioned, the margin is the amount of your available funds that will be held against your open trades. As you open more positions, this amount continues to increase. These funds that are then essentially locked-in by the broker to secure your position are known as your used margin, while the funds still available can be referred to as available margin, or available equity.
We can then use both of these numbers together in the following formula to calculate your current margin level:
Equity/Used Margin x 100 = Margin Level.
As a forex trader, it becomes very important to know this number id you are engaging in margin trading. This is since most top forex brokers will require your margin level to be at least 100% or more in order to avoid a margin call situation. Therefore, you should ensure to keep an eye on this as you are opening new positions.
If you deposit $1,000 in a forex trading account and continue to open 1 position, a typical broker may require $50 in margin (This can be as low as $33 with CySEC regulated brokers, and even as low as $2 with some others). Following the calculation above:
Equity ($1,000)/Used Margin ($50) x 100 = 2000% (Margin Level)
In this case, then you are still well within a healthy margin level, open just a few more small trades though, and this number can change quickly.
What is a Margin Call?
The first important point to note here is that many top forex brokers have what they often refer to as “negative balance protection”. This means that before you even get to the situation of having a margin call, your positions may be automatically closed by the broker.
A margin call happens when your margin level drops below 100%. What this essentially means is that you no longer have enough funds in your account to cover the margin requirements on your open positions.
In this case, you will typically be presented with a couple of options, you could close some of your open positions, or you could deposit more funds to your account. In either case, this is probably a situation that you would prefer to avoid through careful risk management.
The Pros and Cons of Margin Trading
Margin trading can open great possibilities for you as a forex trader to engage in markets to a much higher level than you could with just your own funds. It also means that you can work well to diversify your portfolio with a number of investments in various markets. Beyond this, margin trading means you can always be in a position to make a move in the forex market if you spot an opportunity.
It is well worth remembering though, that as the largest trading market in the world by volume, the forex market can move incredibly fast. Measured in pips, these movements may seem small, and insignificant. If you are engaged in margin trading though, you should remember that your position is very much amplified. This means that even small movements in the asset price, cold mean big changes in your position.
The very best advice you can heed is to take the opportunity that a margin presents, but remain mindful and have a strong risk management strategy in place.
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Forex Market Boosted by Record US Jobs Data
- Payroll Data Smashes Expectation for June
- USD/JPY Increases on Optimism
- Asian Markets also Open Strong on Friday
US markets received an unexpected but welcome boost on Thursday. The release of nonfarm payroll numbers showed that the economy added a huge number of additional jobs beyond expectation. Unemployment numbers also fell. The positive ripple from this has been felt in the forex market around the world with early trading in Asia showing the Japanese Yen up slightly, and a positive start to the day in China, where PMIs came in strong, and other parts of Asia.
Largest Single Month Job Gain in US History
The numbers reported yesterday in terms of US nonfarm payrolls have easily eclipsed previous highs in terms of being the largest single month job gain the country has ever seen. Analysts had forecast a still impressive gain of 2.9 million jobs added, though the actual number came in much greater at 4.8m. This was quickly heralded by President Trump as a sign of the “economy roaring back”. Wall Street also reacted positively on the back of the news, with the Dow Jones rising more than 400 points.
The Labor Department also confirmed that unemployment had fallen more than expected, to a number of 11.1%. This is the lowest since the coronavirus pandemic started. Though these numbers may not paint an entirely accurate picture since they fail to capture the period when states started to rollback their reopening measures, they have still provided a timely economic boost.
JPY Moves Slightly Higher but Remains Hampered
The USD/JPY is one of the most traded markets in the world. Forex brokers though have noted that the market has been trading without much direction for some time. The pair was boosted slightly to a high of just below 108 on news that the US jobs data had come in much better than expected. This positive move was tempered with caution though amid the increasing concern with COVID-19 cases increasing across many American states.
As a well-known safe haven currency in times of difficulty itself, it may be some time before those forex trading the Yen feel like moving out of that safety zone. Later today, Japan will publish their own bank services PMIs from June. Should this number come in greater than expected, it may provoke an additional boost in the market.
Chinese and Other Asian Markets Positive
Yesterday’s positive news from the US has extended into the Asian trading session on Friday. Markets opened strongly across the Asia Pacific region. The Shanghai Composite index jumped almost 1.5% in early trading, with major indices in Japan, South Korea, and Australia, also displaying positive signs.
Markets were further buoyed by the release of Chinese PMI data from the services sector which showed a number of 58.4 for June. This would indicate the sector is growing at the fastest rate since 2010 after much of China returned to normal activity in the month of June.
What are Carry Trades in Forex?
As you continue increasing your knowledge about forex trading and the market in general, more and more new concepts and ideas will pop up. This includes a growing range of trading technique and strategies. One such trading strategy which has been around for a very long time in the industry, is the carry trade. Here we will take a closer look at exactly what a carry is in forex, and provide all the information you need to decide if carry trading is a good strategy for you as you move forward on your trading journey.
The Basics of How a Carry Trade Works
In its most simple form, a carry trade in forex, is borrowing one currency, and using it to buy another. For example, you may borrow (sell) $100,000 Australian Dollars, and use those funds to purchase the same amount of JPY. Placing a carry trade is one of the most popular trading strategies in the entire sector, and used by many traders to benefit from the position of currencies around the world.
So, what is the benefit in borrowing one currency and using it to buy another? This comes from the difference in interest rates between the two currencies. Let’s look again at our example in more detail.
Presuming the interest rate on the Australian Dollar was 4%, and the interest rate on the JPY was 0.1%, a carry trade would be where you buy the AUD/JPY market, as here, what you are effectively doing is selling (borrowing) Japanese Yen, to purchase Australian Dollars. In the most simple of ways, you will now have placed a carry trade. Here you will earn 4% interest on the Australian Dollars you are holding, while paying 0.1% interest on the Japanese Yen you have borrowed. This should leave you in a profitable position if the rate does not change, and is known as a positive carry trade at +3.9%.
Why is Carry Trading in Forex So Popular?
From an outside perspective, even looking at our hypothetical example where there is quite a gap between the interest rates, you may wonder why placing carry trades is so popular when the potential profit may seem quite small. There are two main elements at play in the forex market though which make this a very attractive type of trading strategy.
Currency Pairs: The fact that currencies are traded in pairs make a carry trade very accessible, and convenient for all traders. The difference in interest rates has never been so easy to take advantage of as it is in forex trading, where you can directly trade low and high interest currencies in pairs.
Leverage: The availability of extensive leverage in forex makes it the ideal place to carry trade. Many forex brokers can make leverage of up to 500:1 available on certain currency pairs. This basically means that even a relatively small deposit of $1,000 can open up huge buying power of $100,000 at 100:1 leverage, or more. Dealing with such large numbers, even low percentage profits are very meaningful.
Popular Forex Pairs to Carry Trade
Given the fundamentals of how a carry trade works, borrowing a low interest currency, to buy a high interest currency, then this is precisely what traders are on the lookout for in the forex market when it comes to placing a carry trade. There are a couple of currencies in particular that are most popular in this regard.
As a selling currency, the Japanese Yen is always a very popular choice. This is thanks to the historically very low cost of borrowing in Japan. The country has not had an interest rate of above 0.5% in more than 20-years. Another popular choice as a selling currency may be the Swiss Franc (CHF).
On the buying side, popular choices include both the Australian, and New Zealand Dollar as countries which typically hold slightly higher interest rates, yet are recognized as quite stable currencies.
Benefits of a Carry Trade
A carry trade in forex can be an excellent long-term investment strategy. You will have the potential to benefit from a carry trade even if the rates do not change at all thanks to the difference in interest rates. This makes it perfect for an investor who intends to hold the position for a long time.
Added to that, if the rate does change in your favor, then you can potentially have a sizable profit when added to the interest rate difference, and factoring in the leverage used. The fact that many brokers nowadays also cater for trading with very competitive fees and low spreads also plays to your advantage if placing a carry trade, and is something that many look out for.
Risks Involved in a Carry Trade
With every form of trading, there is always a certain element of risk. With a carry trade, though it is seen as a low-risk strategy, there are still a couple of things to be mindful of.
The market can still move against you. A change in the market can certainly negate any benefits you have gained from the positive interest rate difference. Particularly if you decide to trade in minor, or exotic currency pairs which are less common, you should note that these markets can be highly volatile, and subject to change in a very swift fashion. Some examples include trading with the MXN (Mexican Peso), or NGN (Nigerian Naira). Both may appear attractive for a carry trade, but can be subject to intense volatility. This risk can be amplified even further if you are trading with a lot of leverage.
You should also remember that, just because there may be a positive rate difference at the moment, the monetary policy in every country is subject to change at different times. The perfect example of this would be right now, in the midst of the coronavirus pandemic, many nations have moved to cut interest rates. This has the possibility to really change the dynamics of your carry trade.
Forex Market Majors Trading Lower Amid Coronavirus Concerns
- GBP/USD Struggling after GDP Dip
- EUR/USD Also Sluggish as States Halt Reopening
- Markets Await Key Testimonies After Monday Surge
Major currencies in the forex market are trading slightly lower today. Both the Euro, and Pound have dropped back against the Dollar as concerns over a spike in Coronavirus numbers persist. The final UK GDP figures for the first quarter released today, were also worse than expected. Meanwhile, US markets are looking quiet after a strong rally to open up the week on Monday. This may change as the day progresses and today’s testimony from the Fed Chairman is digested.
UK Suffers Biggest Quarterly GDP Decline Since 1979
Forex trading in the GBP/USD market today was struggling below the 1.23 mark for a number of reasons. One of the major points which seems to have rocked trader confidence in Sterling is the release of GDP figures for the first quarter today. These show a 2.2% drop in GDP, worse than had been expected.
This GDP drop is the largest the nation has seen in more than 40 years. It is compounded by the fact that a double digit drop is expected in the next quarter, and also the fact that a new spike in cases has led to local lockdown in at least one British city. British leader Boris Johnson is due to speak later today where he will introduce plans to inject more than £5 billion into infrastructure in a bid to bolster the economy.
Euro Also Drops Back as Virus Concerns Persist
The EUR/USD is looking to end the quarter in successful territory today although that has been threatened by negative pressure which has pushed the pair down at the beginning of the day. Forex brokers noted that traders are appearing to favor a move back toward the safety of the US Dollar.
This move has largely been led by the uncertainty of the US economic situation as several states have now moved to impose renewed restrictions, or halted their reopening plans as cases of COVID-19 continue to rise again in many areas. This has been the case in New York who have slowed reopening, as well as in Texas and Florida where renewed closures have been put in place on many bars and restaurants after cases in those states showed a heavy increase.
Market Opening Appears Quiet as Traders Await Testimony
Today’s market opening on Wall Street would appear to have hit a lull following yesterday’s great surge to begin the week. The Dow Jones rose more than 500 points yesterday to get the week off to a very positive start. The picture today, pre-market numbers have indicated, is much less active. Many could be awaiting the remarks of Federal Reserve Chairman Jerome Powell, who will address the House Financial Services Committee later today.
These remarks are expected to raise more questions than answers though, with Powell set to comment that the path forward remains very uncertain, and reliant on successfully containing the virus.