Forex Attraction: Leveraged Trading
Leveraged trading means that one doesn't need to shell out the entire amount for a position to trade. This is also called trading on margin where the margin serves as collateral for the entire amount to trade. Now, this is not exclusive to forex because it also exists in the stock and futures market. It just so happens that the attraction of leveraged trading in the foreign exchange market is much better. And the reasons can be broken down to two aspects: more leverage and less cash outlay.
The forex market allows higher leverage than the stock market. One can leverage over 100 times the value of the margin or initial deposit. A reason for this is that foreign currency values change so frequently and the differences or points (in fairly normal circumstances) are not so far from each other. And with higher leverage, traders can increase their buying power with less money investment and earn a high return.
The margin, in forex, is the minimum capital that a trader or investor needs to deposit to trade. Usually the margin is 1% of the position one wishes to purchase, or 100:1. For example, if one's available leverage is 1% and one wants to buy US$100,000 to trade on margin, the deposit required is US$1,000 which is 1% of US$100,000.
To illustrate the advantages of leveraged trading, here's an example:
You figure that the USD (US dollar) is undervalued against the JPY (Japanese yen) quoted at 125.02. You decide to trade on margin and buy 10,000 US dollars against 1,250,200 Japanese yen at 100:1 leverage or 1%. So, your initial capital or margin deposit is 100 US dollars (1% of US$10,000).
As you figured, the USD appreciates against the JPY quoted at 125.62. To make your profits, you sell the 10,000 US dollars at the appreciated value of 1,256,200 Japanese yen. Your profit is 6,000 JPY or 47.76 USD (that's your 6,000 JPY profit divided by the exchange rate of 125.62 JPY). Case in point, your initial margin or investment of $100 earned a profit of $47.76 which is a little over 47% return on investment!
Leveraged trading or trading on margin allows for more buying power and less investment. That means more value for your money. You can earn more profits with less cash outlay. Needless to say, leverage is proportional with risk - the higher the leverage, the higher the risk. So, invest wisely. With good trading decisions, the forex can be your best friend and choice of market for life!