If you want to trade in FOREX you have to master the concept of leverage, this is the possibility of managing a large amount of money using very little of your own money and much of a counterpart (broker) in exchange for a deposit, known as margin deposit that Will be used by the broker in case of loss on investment. Leverage offered in the market is expressed in ratios (50: 1, 100: 1, 200: 1, 400: 1). So if you want to trade $ 100,000, but you only have $ 5,000 and we have a leverage of 100: 1 (100 times initial capital), then the broker will separate $ 1,000 from the account as margin deposit.
To buy $ 100,000 and earn $ 2,000, then the profitability would be 200%. The initial investment is $ 1,000 and not $ 100,000. Without leverage, the return would be only 2%, requiring 100,000 dollars to invest. That’s one of the pro, now the cons. Leverage allows, in turn, to lose more if not controlled. Of losing $ 2,000, the return would be -200%. Leverage, never forget this, is a double edged sword.
Now let’s move on. This is expressed as a percentage of the position that the inverter opens. So if 100,000 units are traded (bought) and 1,000 is deposited, then the margin will be 1% (1,000 / 100,000). Based on the margin deposit for a given transaction, you can calculate the maximum leverage offered by the account. If the required margin is 1% and we operate 100,000 units then the margin deposit is 1,000 (100,000 x 1%), so the leverage ratio will be 100: 1 (100,000 / 1,000 = 100/1).
Before we continue define the concepts of lots, pips, spread. A lot is the trading unit in the Forex market. A standard lot equals 100,000 units of the base currency (read as 1 lot). A mini lot equals 10,000 units of the base currency (read as 0.1 lots). Finally we have the micro lot that equals 1,000 units of the base currency (read as 0.01 lots).
A pip is the minimum increment that a pair can have. Pip means “point of interest of the price”. For most pairs a pip is ten thousandth part of a exchange rate or quote (1 / 10,000). The pips are counted from the fourth decimal place. The value of a pip depends on the number of lots being traded and the exchange rate at which the transaction is closing (bid in case of closing a purchase and ask in case of closing a sale). For simplicity assume that 1 pip equals 10 $ in a standard lot (1), 1 $ in a mini lot (0.1) and 0.1 $ in a micro lot (0.01).
The spread is the difference between the ask-bid price, this difference is the amount the broker charges you for opening an operation or, in other words, your gain (remember that the maintenance margin is Returns in case of gain). The bid is the price our broker is prepared to buy (traders sell at this price).
The ask is the price at which a broker is prepared to sell (traders buy at this price). The spread is usually constant under normal market conditions, however, under volatile conditions the spread may increase (news such as rising interest rates or non-farm payrolls).
The next installment will deal with the (fearsome) margin call,
Parochial announcement: Full disclosure: this delivery and the ones that will follow in the Forex issue have been made for the most part by Renzo February, a professional with extensive experience in the subject. I invite you to follow it on Twitter.