Forex Trading

One of the biggest falsehoods that are perpetuated among foreign exchange traders is that it is smart to use a high amount of leverage to make money fast.  When forex traders use leverage, they are borrowing money from their broker to invest in currency.  Due to the size and liquidity of the foreign exchange markets, most brokers allow very large loans in relation to the size of the investor’s account.  In fact, some forex brokers let their account holders borrow as much as ten to forty times the amount of cash that the account currently holds.  The idea behind this is that more money invested means greater profits, but this way of investing often has a downside when the currency price drops. 

Because such large sums of money are being exchanged, brokers often keep a tight reign on the borrowed funds, and will execute a margin call on the position if it falls below a certain level, involuntarily selling the currency to pay back the loan.  As is always the case when an instrument is sold for less money than the original buying price, the funds garnered from the sale will not fully cover the amount of the loan.  In cases where the trader used a high rate of leverage, the entire count could be wiped out, and there may even be a debt to pay back.  While leverage is a powerful tool that can be used to make more profit than possible with just a cash account, it should be used extremely cautiously and in moderation.

Another way that forex traders often get themselves in trouble is overtrading.  Many believe that they can fire off trades all day like a machine gun, and the more trades they make, the bigger the profits will be at the end of the day.  This is simply not true, and is a great way to steadily line the pockets of banks, market makers, and brokers with the contents of their forex brokerage accounts.  In each forex trade, there is a bid price and an ask price, which represent the price at which the buyer is willing to pay for the target currency and the amount at which the seller is willing to part with it.  There is always a difference between these two prices called a “spread”, and this small amount of money goes to the market maker, which is the institution that facilitated the trade.  While small, this amount can add up over a large number of trades, and can negatively affect one’s account balance.