It is important to understand the concept of margin and leverage in forex trading. These tools allow forex traders to control substantially greater trading positions. Margin is fundamentally the amount of money in a trader’s account that is required as a deposit in order to open and maintain a leveraged trading position.
In short, leverage allows traders to control larger positions with a smaller amount of actual trading funds. For instance, in the case of 50:1 leverage (or 2% margin required), US$1 in a trading account allows control to a position worth US$50. As a result, leveraged trading can be a “double-edged sword” in that both potential profits as well as losses are magnified according to the degree of leverage used.
To illustrate further, let’s look at a typical USD/CAD (U.S. Dollar against Canadian Dollar) trade. Without leverage, to buy or sell 100,000 USD/CAD will require the trader to set up US$100,000 in account funds, the full value of the position. But with 50:1 leverage (or 2% margin required), only US$2,000 is required to open and maintain the US$100,000 USD/CAD position.