The traditional players – banks,
governments, multinational companies – dominate the forex market activity. However, retail traders
are increasingly moving into the market. How can smaller-scale retail traders participate in the
same market as banks? The key is margin trading. Margin is a powerful tool, but there is also
risk associated with it. An understanding of how margin works is crucial for any forex trader.
Example:
A trader has USD $10,000 cash in a forex trading account. He buys
200,000 Euros against the US dollar (EUR/USD) at 1.3325. The initial
margin requirement is 3% or USD $7,995 (200,000 x 1.3325 x 0.03). Every
pip movement in the EUR/USD is now worth USD $20. The maintenance margin
requirement is $7,995.
Scenario A: market rises to 1.3512
The trader has a gain of 187 pips or $3,740 (187 x 20). This is the equivalent to
46.7% return on the margin deposit, or a 37% return on total equity.
Scenario B: market falls to 1.3195
The trader has a loss of 130 pips or $2,600 (130 x 20). The trader now has equity
of $7,400. This is below the maintenance margin requirement of $7,995 and the account
will receive a margin call. The trader has a 32.5% loss on his initial margin deposit
or a 26% loss in account equity.
What is the risk?
There is always risk associated with margin trading. Traders experience profit or loss on the position size
that they control, not on the small cash outlay that they make (initial margin). Risk can be compounded if
traders over-leverage their trading accounts, or use up almost all of their buying power. Trading in such a
manner can quickly lead to significant percentage losses and even account liquidation.
Managing risk
Managing risk starts with having a game plan. A number of factors, such as the high degree of speculation,
can make market conditions very volatile. To offset that volatility, successful forex traders pre-determine
each trade's parameters, setting such key points as how much he or she is willing to lose on a particular
trade or the maximum percentage of an account that may be leveraged at one time. These conditions can be
set within the trading platform. The most commonly used tools are:
- Stop loss orders
- Stops attached to positions
- Stops as part of contingent orders
- Trailing stops
- Risk/reward ratio using if/then or one cancels other orders
If a trader fails to manage the risk in their account and the account becomes under-margined, Questrade
will mitigate debit risk by liquidating positions.
There are a few simple ways to familiarize yourself with the risks of the forex market and the tools
provided by Questrade. First, practice with a demo account. This will expose you to the market and the
risk management tools, giving you the opportunity to become comfortable with the environment. Second,
take instructional courses offered by our third-party training providers.
We also encourage you to carefully read Questrade's Forex Risk Disclosure Statement.