What is Margin Trading?

Trading currencies on margin lets you increase your buying power. Here's a simplified example: If you have $2,000 cash in a margin account that allows 100:1 leverage, you could purchase up to $200,000 worth of currency-because you only have to post 1% of the purchase price as collateral. Another way of saying this is that you have $200,000 in buying power.

What are the benefits of margin?

With more buying power, you can increase your total return on investment with less cash outlay. To be sure, trading on margin magnifies your profits AND your losses.

Here's a hypothetical example that demonstrates the upside of trading on margin:

With a US$5,000 balance in your margin account, you decide that the US Dollar (USD) is undervalued against the Swiss Franc (CHF).

To execute this strategy, you must buy Dollars (simultaneously selling Francs), and then wait for the exchange rate to rise.

The current bid/ask price for USD/CHF is 1.6322/1.6327 (meaning you can buy $1 US for 1.6327 Swiss Francs or sell $1 US for 1.6322)

Your available leverage is 100:1 or 1%. You execute the trade, buying a one lot: buying 100,000 US dollars and selling 163,270 Swiss Francs.

At 100:1 leverage, your initial margin deposit for this trade is $1,000. Your account balance is now $4000.

As you expected, USD/CHF rises to 1.6435/40. You can now sell $1 US for 1.6435 Francs or buy $1 US for 1.6440 Francs. Since you're long dollars (and are short francs), you must now sell dollars and buy back the francs to realize any profit.

You close out the position, selling one lot (selling 100,000 US dollar and receiving 164,350 CHF) Since you originally sold (paid) 163,270 CHF, your profit is 1080 CHF.

To calculate your P&L in terms of US dollars, simply divide 1080 by the current USD/CHF rate of 1.6435. Your profit on this trade is $657.13

SUMMARY

Initial Investment: $1000
Profit: $657.13
Return on investment: 65.7%

If you had executed this trade without using leverage, your return on investment would be less than 1%.