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 US$1.9 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 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 center, first to Tokyo, London, and New York. Unlike any other financial market, investors 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 'interbank' market, due to the fact that transactions are conducted between two counterparts over the telephone or via an electronic network. Trading is not centralized on an exchange, as with the stock and futures markets.
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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.
Benefits of MarginWith 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 1.2322/1.2327 (meaning you can buy $1 US for 1.2327 Swiss Francs or sell $1 US for 1.2322 francs)
Your available leverage is 100:1 or 1%. You execute the trade, buying a one lot: buying 100,000 US dollars and selling 123,270 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 1.2415/20. You can now sell $1 US for 1.2415 Francs or buy $1 US for 1.2420 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 dollars and receiving 124,150 CHF) Since you originally sold (paid) 123,270 CHF, your profit is 880 CHF.
To calculate your P&L in terms of US dollars, simply divide 880 by the current USD/CHF rate of 1.2415. Your profit on this trade is $708.82
SUMMARY
Initial Investment:
$1000
Profit:
$708.82
Return on investment:
70.8%
If you had executed this trade without using leverage, your return on investment would be less than 1%.
Managing a Margin AccountTrading on margin can be a profitable investment strategy, but it's important that you take the time to understand the risks.
You should make sure you fully understand how your margin account works. Be sure to read the margin agreement between you and your clearing firm. Talk to your account representative if you have any questions.
The positions in your account could be partially or totally liquidated should the available margin in your account fall below a predetermined threshold.
You may not receive a margin call before your positions are liquidated.
You should monitor your margin balance on a regular basis and utilize stop-loss orders on every open position to limit downside risk.
For information on managing margin in your FOREX

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