Margin trading in the forex market
Margin trading in the forex market
Trading on margin is available in both the equities and forex markets, but the mechanics on how margin works has some key differences. With equities, margin trading typically means a brokerage firm lends an account owner a portion (typically 30% to 50%) of the total purchase price, which boosts buying power by a commensurate amount. Securities already held can be used as collateral, and the trader pays interest on the money borrowed.
In the forex market, though, margin constitutes a good-faith deposit placed with a broker in order to open and maintain a position. Here, margin is not a borrowing cost or interest, but is a portion of the trader’s account balance set aside while the forex position remains open. For the most actively traded major currency pairs (such as EUR/USD, USD/CAD, and USD/JPY), the margin requirements are typically 2% to 5% of the notional value of the base currency.
A 2% margin requirement for a EUR/USD position, for example, provides 50:1 leverage, meaning that if the total position value for the EUR/USD position is $50, the margin requirement needed for the good faith deposit will be $1. If the EUR/USD is trading at 1.10, the total margin requirement for a standard lot position of 100,000 units would be $2,200 (0.02 x $110,000 = $2,200) and would have a total position value of $110,000.
Base vs. quote currencies
Margin requirements are calculated using the base currency. However, even if the base currency isn’t the U.S. dollar, margin still needs to be converted to U.S. dollars. Most brokers only allow their customers to hold U.S. dollars in their account. At Charles Schwab Futures and Forex, only U.S. dollars can be physically held in the forex account. As a result, the margin requirement fluctuates as the base currency changes relative to the U.S. dollar.
For example, if the margin requirement is 5% for GBP/USD, a position of 10,000 GBP/USD carries a margin requirement of 500 British pounds. As the pound fluctuates against the U.S. dollar, the margin requirement for that position will also fluctuate. If you’re a Charles Schwab Futures and Forex client trading forex on the thinkorswim® platform, these margin calculations are automatically tracked for you.
