Margin Trading

Transactions on the FOREX market are carried out on the principle of margin trading. This means that the broker gives you the opportunity to work with the sum, which is significantly greater than your deposit (your own funds paid as a deposit). This, in turn, means that even with a slight fluctuation, income from operations may be compared with trader’s own security deposit. Hence, the high profitability of foreign exchanges operations and the high attractiveness of FOREX for private investors with little money.

Let’s consider in more details how the margin trading goes on.

The main principle is - the broker provides the trader with “the credit shoulder” or financial leverage, as it is called. To start trading, the trader makes deposit on his own account, which bears the name of the collateral deposit. The collateral deposit must be at least a certain percentage of the size of the proposed transaction. When the trader wishes to make a transaction, the broker evaluates how many times the amount of the transaction is more than the own funds of the trader. If the ratio of the amount of the transaction to ones' own funds is in the range of maximum size of “the credit shoulder”, the broker provides his own funds for the transaction, taking trader’s funds in the pledge.
 
For example:

Suppose trader’s fund is $ 1000. The trader decided to make a transactional to buy 40,000 US dollars against the yen. If the maximum leverage provided by his broker, is equal to 1: 100, in this particular situation, the credit shoulder is 1000/40000 = 1:40 and it fits in the permissible limits. The broker will help the trader to perform the planned transaction. The deal would have been possible in that case, if its estimated value was equal to $ 1000 (credit shoulder 1:1) or 100000 USD (credit shoulder 1:100).

In the process of the transaction trader’s capital serves as insurance collateral, which guarantees to the broker "intactness" of funds given for trading. If a trader, trading on the FOREX, failed a transaction, and lost part of the funds given by broker for trading, the broker’s losses are automatically compensated from the collateral deposit of trader. As a result, the broker's own funds are the same as they were before the transaction and deposit of the trader decreases. If the losses are such that the broker will write off all funds from the trader’s deposit as loss repayment, the trader will not be able to make the new transactions. Thus, in case of the failed trading, the trader can lose only their own funds, not risking to be in the debt from the broker under any circumstances. For beginners as well as for the experienced traders this is quite an important factor, in favor of the foreign currency exchange market. In the stock- market, for example, in case of unsuccessful options trading, the trader has unlimited financial responsibility to the broker or, to put it simply, could lose much more than a deposit.