One of the things which traders new to leveraged trading sometimes get a bit wrong is margin requirements. This is particularly true where forex is concerned. The margin requirement for a position is based on the value of that position, not on the size of it.
For those in a market like futures this generally isn’t something which gets a lot of thought. Brokers and exchanges set margin requirements. They are based on the value of the futures contracts in question (some base %), but the process is often opaque to us as traders. We just see that the margin requirement on Cotton is $1700 per contract, or something like that.
In forex trading margin requirement percentages are more immediately visible as they are directly linked to the leverage ratio brokers permit us. If we trade at 100:1 leverage then our margin requirement is 1%. That means we need to put up 1% on the trades we make – the value of it, not the size. In some cases that is the same thing. If we were to buy 100,000 USD/JPY then the size of the trade and the value of the trade are the same – both $100,000. If, however, we’re buying 100,000 GBP/USD at 2.00 then the value of the trade, and therefore the basis for determining our margin is $200,000, not $100,000.
It’s a simple mistake, easy to make if one doesn’t stop to think about it.
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About the Author
John Forman, author of this blog, has traded for more than 20 years, is a professional market analyst, and authored The Essentials of Trading. He is an active participant in trading forums, consults for trading related businesses, as published literally dozens of trading articles, and has been quoted in a number of books and in the media.
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