The degree of leverage in trading financial products has been increasing over the years. Traditionally if a trader wanted to buy stocks and shares, or other instruments, they would have to put up the full amount of that purchase in order to do the deal. Through time the markets became more competitive, prices more transparent and investing and trading became more available to “the man on the street” and was no longer solely the domain of the banks and big institutions. Inevitably, the banks and exchanges started to offer margin trading facilities. This is where instead of having to provide the full amount of the deal upfront, the amount required is merely a certain percentage of the deal value. What the percentage is depends on what the underlying instrument is and the institution offering the margin facility. Typically those instruments with a larger daily potential price move have less leverage, and those whose daily price swings are lower will offer more. So equity market margin rates may be 10-20% whilst foreign exchange rates are typically 2% or less because on average the daily price changes are sub-1%, so traders need more leverage to make money.
This gives players the chance to make bigger returns as the positions they can hold in the market are much larger. Conversely however, the risks are greater too.

An Example

The concept of margin forex is perhaps best understood using an example. Most Forex market makers permit 50:1 leverage, but also, crucially, require you to have a certain amount of money in your account to protect against a critical loss point. For example, if a $1,000,000 position is held in EUR/USD on 50:1 leverage, the trader has to put up $20,000 to control the position. However, in the event of a declining value of your positions, Forex market makers, mindful of the fast nature of Forex price swings and the amplifying effect of leverage do not allow their traders to go negative and make up the difference at a later date. In order to make sure the trader does not lose more money than is held in the account. There fore clients are asked to place stop loss orders to protect there equity. If the trader has $50,000,000 in his account, and he is buying a E1,000,000 of EUR/USD, he has $20,000 of his $50,000 tied up in margin, with $30,000 left to allow his position to fluctuate downward without being closed out.

The Foreign Exchange market, also referred to as the “Forex” or “FX” market, is the largest financial market in the world, with a daily average turnover of well over US $1 trillion -- 30 times larger than the combined volume of all U.S. equity markets.

“Foreign Exchange” is the simultaneous buying of one currency and selling of another. Currencies are traded in pairs, for example Euro/US Dollar (EUR/USD) or US Dollar/Japanese Yen (USD/JPY).

There are two reasons to buy and sell currencies. About 5% of daily turnover is from companies and governments that buy or sell products and services in a foreign country or must convert profits made in foreign currencies into their domestic currency. The other 95% is trading for profit, or speculation.

For speculators, the best trading opportunities are usually with the most commonly traded (and therefore most liquid) currencies, called “the Majors.” Today, more than 85% of all daily transactions involve trading of the Majors, which include the US Dollar, Japanese Yen, Euro, British Pound, Swiss Franc, Canadian Dollar and Australian Dollar.

A true 24-hour market, Forex trading begins each day in Sydney, and moves around the globe as the business day begins in each financial centre, first to Tokyo, then London, and then New York. Unlike any other financial market, traders can respond to currency fluctuations caused by economic, social and political events at the time they occur - day or night.

The FX market is considered an Over The Counter (OTC) or ‘inter-bank’ market, as transactions are conducted between two counterparts over the telephone or via an electronic network. Trading is not centralized on an exchange, as it is with the stock and futures markets.
As with all financial products, FX quotes include a ‘bid’ and ‘offer’. The ‘bid’ is the price at which a dealer is willing to buy (and clients can sell) the base currency for the counter currency. The ‘ask’ is the price at which a dealer will sell (and clients can buy) the base currency for the counter currency.

The US dollar is the centrepiece of the Forex market and is normally considered the ‘base’ currency for quotes. In the “Majors,” this includes USD/JPY, USD/CHF and USD/CAD. For these currencies and many others, quotes are expressed as a unit of $1 USD per the other currency quoted in the pair. The exceptions to USD-based quoting include the Euro, British pound (also called Sterling), and Australian dollar. These currencies are quoted as dollars per foreign currency as opposed to foreign currencies per dollar.

Currency prices are affected by a variety of economic and political conditions, most significantly interest rates, inflation and political stability. Moreover, governments sometimes participate in the Forex market to influence the value of their currencies, either by flooding the market with their domestic currency in an attempt to lower the price, or conversely buying in order to raise the price. This is known as Central Bank intervention. Any of these factors, as well as large market orders, can cause volatility in currency prices. However, the size and volume of the Forex market makes it impossible for any one entity to “drive” the market for any length of time.

Currency traders make decisions using both technical factors and economic fundamentals. Technical traders use charts, trend lines, support and resistance levels, and numerous patterns and mathematical analyses to identify trading opportunities. Fundamentalists predict price movements by interpreting a wide variety of economic information, including news, government-issued indicators and reports, and even rumour.