Facts about Futures Margins and Leverage
Before a forex trader signs an account to engage in futures market trading, he must have a clear comprehension of the concepts behind margins and leverage in futures contracts. One should begin futures trading only when the principles of margins and leverage are understood.
In several ways, margins and leverage can be said to comprise different properties of the entity, in the sense that one cannot be understood without the other.
Leverage can be explained in the following way: most futures accounts amount to little more than a few thousand dollars, (although there are of course exceptions to this rule). As a result, the money involved in a single futures contract entered by a trader is worth little more than a few dollars or cents.
To compensate for this, forex brokerage and futures firms allow their clients to use the firm's funds as leverage to increase the potential profits. The leverage varies greatly from broker to broker and also from contract to contract. Generally speaking, the smaller the account, the higher the leverage offers. The ratios range from 10 to1 to 300 to 1.
Of course, being borrowed funds, leverage entails some risks; if you use a substantial leverage, you could theoretically earn thousands with an increase of a few percentage points in the stock market. But your entire account could be wiped out if the market takes a dive.
If you trade in the stock market, margins would be a familiar term: it denotes the money borrowed from a broker or institution to purchase shares of stocks. Typically, margins are in the 50% range. What the forex trader must know is that margins in futures markets have different rules.
Margins in futures contracts amount to no more than 8%, and there is no interst payment either. However, unlike in stocks, futures margins are variable, subject to the volatility of the forex futures market.
For each futures contract that a forex trader wants to purchase, you need to make a deposit or down payment, called the initial or original margin. Through the course of your trading sessions, the broker will monitor your initial margin, and if it reaches a certain amount -the maintenance margin- you will receive the margin call.
The margin call can come in the form of a letter, a phone call or email. Whatever the method, the message will be the same: you need to deposit more money in your account. If you do not, the firm, as stated in the sign up sheet, will have the right to liquidate your contract to cover the loss.
For example: you purchase a futures contract with an initial margin of $5,000 and a maintenance margin of $4,000. If the contract goes up in value, it will be added to your margin; if it falls to $3,500 you will get a margin call for $500.
For a forex trader learning the facts about futures margins and leverage are fundamental and cannot be ignored. By understanding their concepts, you will be more aware of the terms of your contract more clearly.