Using Margin Calls In Forex Trading
The word 'trading' typically means buying something at a price and then selling it at a higher price, thus making it profitable for you. That originally meant that you'd be shelling out your own cash in order to buy the commodity you're looking at. With forex trading, though, the system in place is designed to give you an easier time. However, that same system can also give rise to margin calls.
In forex trading you can choose to buy anything from a few of a certain currency to millions of it. But when you also profit just fractions of a cent per unit in forex trading, it's not worth it to go small. You have to trade big-time.
That's where the system of leveraging comes in. Forex brokers realized that few people could actually afford to do forex trading on the scale that would make them some profits. To solve this problem, the brokers lend you money when you trade, matching your investment dollar with several of theirs. If you want an idea of how large they lend, it's not rare for brokers to leverage at a ratio of 1:100 - 100 of their dollars for every 1 of yours.
Once you've grasped the basics of the leveraging system, it's easy to see just how much is at stake on the market for forex brokers. They invest a hundred times what you do on the market, and thus stand to lose a hundred times what you do as well. The brokers, however, aren't without a Plan B.
If, for example, you invested in euros because you thought its value would be going up soon, you'd have to make the purchase through your broker. There would be some leveraging and your broker would invest a hundred times what you did in euro. Now, it's not unknown for currencies to take a small, temporary slump before appreciating in value. Many forex trends have that particular characteristic, and you would've just had to wait it out to make a profit. The broker, though, won't see it that way.
Brokers that leverage are entitled to do what's known as a margin call. If your hypothetical euro investment suddenly seemed to be a losing bet, the broker could make the call to sell even without your consent. It doesn't matter if you personally think that the euro will be recovering in a couple of days anyway. If the broker wants to cut their losses, they'll liquidate your investment and leave you at a loss.
The mechanics of margin calls in forex trading aren't always as harsh. Many forex investors get to hold on to losing currencies because they're established relationships with their brokers, so there's a bond of trust between them. If you have good credit with your broker, chances are good that they'll wait for your decision instead of making a margin call.
As you can see, things don't really turn out in anybody's favor when the broker makes margin calls. You just need to be careful, especially if you are new to the business of forex trading.