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To effectively trade any market or instrument starting funds need to be geared, otherwise successful trades would result in relatively minimal gains.
For example with currency trading if you simply buy a currency physically when you expect its price to go up, a relatively large percentage change in price of the currency (in the order of say 1% - 5%) would still only translate to the same percentage gain in your trading funds. Therefore if you start trading with a small initial bank, unless you were to have a high amount of funds to trade, not gearing your starting funds would make your progress toward profit very slow indeed.
This is why internet currency trading platforms provided by reputable brokers provide the ability for the trader to highly gear their starting funds in the order of 100 to 1.
Using preferred brokers, if you start trading currencies with say USD 3000 you can buy or sell up to USD 300,000 worth of the currency in the currency pair you are trading.
The trading site will generally provide two levels of risk control to protect the trader. Apart from the stop loss (which is a price level generated by Build Your Trading with each Build Your Trading alert) there is the broker requirement that funds to the value of the minimum margin level must be maintained in the trader’s account with the broker.
This means that in the above example if you have bought or sold USD 300,000 worth of say British Pounds and your account with the broker drops below the value of USD 3000 (100 to 1 gearing) then your position in the market will be automatically squared (taken out of the market) at that price level. This ensures that your account balance does not go lower than the margin (in this case USD 3000). Liability for losses beyond the margin are subject to broker/client agreements which vary from broker to broker.
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Using preferred brokers, this means the following. In practice if you were to have bought or sold USD 300,000 against another currency and your trade were to go wrong, and if your trading account balance started out at say USD5000, then as you would be taken out of the market automatically when your account balance reduced to USD 3000, that means the maximum loss you could make would be USD 2000.
The important consequence of this (assuming you trade with a broker set up this way) is that when you trade currencies the most you can lose is less than what you have in your broker account.
Compare this to a common way of buying and selling shares. In the above example USD 300,000 worth of currency could be bought or sold with a trader account of USD 5000. However, to buy USD 300,000 worth of shares, if gearing were required you would need to approach a margin lender if you wished to gear your position with the share purchase.
A margin loan for the purposes of purchasing 300,000 worth of shares would probably be at the most 240,000 provided against an equity from the trader of about 60,000. In addition further security (assets) may also be required.
The risk is that in a share market decline the margin loan would be called in (margin call) and the trader or investor would be required to instantly cover in this case 80% of the share value decline. In a worse case scenario the collateral to the value of 240,000 may be seized by the lender if the shares become worthless.
In this example which do you think has more risk – trading USD 300,000 worth of currency or trading USD 300,000 worth of shares. This paradox is only becoming clear to some share market investors in recent times, now that the bull run in shares over the last few years appears to be coming to an end. Unlike the share trader, the currency trader does not have to borrow to trade currencies in the above example.
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