You may be surprised at the margin, how can retail investors like you be able to trade such large-scale currencies. You can imagine that your broker lent you $ 100,000 to buy currency. And it only requires you to give it $ 1,000 as a credit guarantee, and it will keep the funds on your behalf. Does n’t it sound too beautiful and does n’t feel real? This is how leveraged trading works.
The origin and working principle of leverage in foreign exchange transactions—Yuhui International
The leverage you use depends on your broker and the level you can afford.
Generally speaking, brokers will first require traders to deposit a fund in their account, which is known as the “account margin” or “initial margin”. Once you have deposited your funds, you can use it to trade. Brokers will also stipulate the level of margin required by each exchange.
For example, if the leverage ratio is 100: 1 (or 1% of the position requirement), you intend to trade $ 100,000, but you only have $ 5,000 in your account. This is no big deal, because your broker will withdraw $ 1,000 from $ 5,000 as your down payment, or “margin”, and allow you to “borrow” the remaining funds. Of course, any loss or profit will be written down or increased in your account cash balance.
The minimum margin requirements vary by broker. In the previous example, the broker allowed a 1% margin. This means that for every $ 100,000 traded, the broker wants you to deposit $ 1,000 as a trading position.
How to calculate profit and loss?
Now that you know how to calculate pip value and what is leverage, let us now see how to calculate profit or loss.
Let’s buy US dollars and sell Swiss francs.
- Your quotation is 1.4525 / 1.4530. Since you are buying US dollars, the “sell price” of 1.4530 will be your “buy” price, or the price that other traders intend to sell;
- You buy 1 standard lot (100,000 units) USD / CHF at 1.4530 points;
- After a few hours, the exchange rate becomes 1.4550 and you intend to close the position;
- The latest price of USD / CHF is 1.4550 / 1.4555. Since you are planning to close the position, and you originally bought it, now you are ready to close the position, you need to sell USD / CHF, so you must execute the “buy price” of 1.4550;
The spread between 5.1.4530 and 1.4550 is 0.0020, or 20 points;
- Calculate your profitability: (0.0001 / 1.4550) * 100,000 * 20 = 6.87 USD / point * 20 points = 137.40 USD.
Remember, when you enter or exit a trade, you must be clear on the spread between the “buy price / sell price” quotes. When you buy a currency, you will execute the selling price, and when you sell, you will execute the buying price.