Page 61 - Ultimate Guide to Currency Trading

of losing on the mort-gages they give out. This is precisely why they ask for money down. This is the
amount that the home will fall in value if the bank has to take over the mortgage and sell it at what is
often referred to as a fire sale. Fire sale prices are the prices that the homes will sell for in a one-day
auction. If the market is bad, then the reserve or the down payment will be hiked up to cover any
potential losses by the bank.

The same idea exists in the Forex business. The required ratio at 50:1 is actually 2 percent cash
down on the loan to buy securities (currency pairs). At 20:1 the deposit is 5 percent, and at 10:1 the
deposit is 10 percent. As you can see, by nature and mathematics, a 10:1 ratio is safer than a 50:1
margin ratio strictly because you have more money as a deposit.

As you put more money in your account, you will be able to trade with more capital, as the
loan is extended further and further up to the limit of your cash balance. You will also earn interest at
the prevailing rate on the cash balance in your account (as well as any interest on any trades that have
a positive interest differential).

Margin Call Basics

After you have deposited money into your Forex account, you will then have to set the amount of
margin ratio that you would like to trade at, whether it is 10:1, 20:1, or 50:1. Once you establish your
margin ratio, the next thing you will have to do is determine how much of that margin amount you will
use at any one time. If you are setting up a long-term trade, you might only use 10 percent of the
available margin. If you are doing an overnight-hedged trade, you might use 33 percent of your
available margin, and if you are setting up a short-term scalping trade, you might decide to use 50
percent of your available margin. This means that if you were trading at 50:1 and you had a balance of
$1,000 in your account, you would be able to use $16,666 at a time (this is using 33 percent of your
account for an overnight trade). Shown mathematically it looks like this:

$1,000 x 50 = $50,000 x 33% = $16,666

While more profit can be squeezed out of your account when you utilize more of your
available margin, the more you use, the more chance you run of getting a margin call. Most Forex
brokerage firms have a set floor as to the amount that a trade can reach before it is automatically
closed out in what is called a margin call. A margin call is when the cash equity in the account falls
below a level that is sufficient to keep the trade liquid. It is usually 5 percent to 10 percent the value of
the open trades. If this level is breeched, then you will get a margin call. When you get a margin call,
the Forex broker will not actually call you and give you time to get new money in the account. They
will just automatically close out all trades that you have on the books, whether they are gainers or
losers.