To fully utilize and appreciate
the unique benefits you can enjoy by investing in the forex market, you need to
understand how each trade you enter works. In particular, you need to
understand what each of the following three concepts means:
§ Leverage
§ Margin
§ Spread
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Leverage
Leverage
is probably the one characteristic of the forex market that intrigues
individual investors the most. Leverage is the ability to convert a small
amount of power into a larger amount through the use of a tool. Imagine you are
asked to move a large boulder from the spot where it is currently resting. You
could certainly try to push and move the boulder with your bare hands, but your
job will be much easier if you can use a tool—like a large pole—that you can
place under the boulder that will give you some leverage.
The same
principle holds true when you are investing in the forex market. You can make
money by investing just your own money, but you can make much more money if you
can use the tool of financial leverage by borrowing money from your dealer.
You can
lever, or increase the investing power of, your forex accounts by using some of
your own money to enter a trade and then borrowing the rest from your dealer.
For example, the forex market allows you to control $100,000 with as little as
$1,000 of your own money. That means you only have to pay for 1 percent of the
position with your own money. You can borrow the remaining 99 percent of the
purchase price from your dealer.
The
leverage you enjoy in the forex market is determined by the margin you are
required to post for each trade.
$10.000 Initial
Starting Capital
1Lot of EURUSD @ 1.35
Lot Size : 10.000
Pip Value: $1/Pip
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Laverage Ratio
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Ratio (%)
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Margin Required
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Capital % Used
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400:1
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0.25
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$33.75
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0.34
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200:1
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0.50
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$67.59
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0.68
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100:1
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1
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$135
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1.35
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50:1
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2
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$270
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2.7
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20:1
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5
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$675
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6.75
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1:1
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100
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$13.500
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Can’t open a position
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The Power of Laverage
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Laverage
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Capital Invested
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Purchase Power
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Money Value of 1% Profit
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ROI
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2:1
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$1000
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$2.000
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$20
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2%
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10:1
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$1000
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$10.000
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$100
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10%
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50:1
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$1000
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$50.000
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$500
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50%
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100:1
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$1000
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$100.000
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$1.000
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100%
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150:1
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$1000
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$150.000
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$1.500
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150%
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200:1
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$1000
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$200.000
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$2.000
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200%
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Losing
Situation, Hit a StopLoss
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Risky Trader
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Conservative Trader
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Starting Capital
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$10.000
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$10.000
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Laverage
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100:1
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100:1
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Pip Value
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$10/pip
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$10/pip
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Cuurency Pair rate
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EUR/USD1.35
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EUR/USD1.35
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#of Lots
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5
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1
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Lot Size
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10.000
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10.000
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Margin Used
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$6750
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$1350
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Stop Loss
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50 pips
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50 pips
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Loss Of Capital
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$2500 (25%)
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$500(25%)
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Remaining Capital
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$7500 (75%)
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$9500 (75%)
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Top Broker For Trading partner
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Margin
The forex
market is an exciting market because your dealer is willing to lend you money
so you increase your profit-generating potential in all of your trades. Before
your dealer lets you borrow money, however, you have to show that you have some
money to cover any losses you may incur. Margin is the money you set aside with
your dealer for safe keeping to prove that you are able to cover your losses.
For
example, if you buy the EUR/USD, you will be required to set aside 1 percent of
the position size as margin. That means if the position size is 100,000 euros,
you will be required to set aside the equivalent of 1,000 euros to prove to
your dealer that you can cover losses of at least 1,000 euros should your trade
move against you.
Different
currency pairs have different margin requirements. Major currency pairs have
lower margin requirements because their high levels of liquidity make it easier
to enter and exit your trades
positions without incurring
unexpected losses. Exotic currency pairs have higher margin requirements
because their low levels of liquidity make it harder to enter and exit your
trades quickly.
Many beginning forex traders
get confused by thinking that the money they set aside as margin actually goes
toward purchasing currencies. It does not. You borrow 100 percent of the
purchase price from your dealer. Your margin only shows your dealer you have money
to cover any losses that you may incur.
When you buy a currency pair,
you do not have to come up with the cash on your own. Your broker loans you
enough of one currency to buy enough of the other currency in the pair. For
example, if you click on the “Buy” button to buy the EUR/USD pair at 100,000
units, your dealer will loan you enough U.S. dollars (USD) to buy 100,000 euros
(EUR). If the EUR/USD exchange rate is 1.4000 at the time, your dealer will
loan you 140,000 U.S. dollars to buy 100,000 euros.
The Spread
The spread is
the distance between the price at which you can buy a currency pair and the
price at which you can sell a currency pair at any given moment.
You cannot buy
a currency pair and immediately turn around and sell it at a lower price. The
price at which you can buy a currency pair (the “Ask” price), is always higher
than the price at which you can sell a currency pair (the “Bid” price).
Whenever you enter a trade, you start out with a small loss because of
the spread. You must overcome the spread—hold onto the trade long enough for it
to move through the spread—before you will be profitable on your trade
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