How To Avoid Margin Calls
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With far too rapid price fluctuations and enormous volumes of trade, Forex trading is not for the faint hearted. While you could make a fortune overnight if you strike it lucky, the downside is you could lose everything equally fast. If you are planning on entering the Forex trading zone backed by a limited amount of money, one of the traps you need to be careful of not falling into is that of margin calls.
Understanding the Concept of ‘Margins’
Because of the large amounts of money that changes ownership at every trade, most of the players in any Forex trading market will include larger organizations and corporates and even governments. Individual investors can find it almost impossible to find that kind of money to go up against such powerful adversaries. In order to give them a toehold into the Forex trading market, many brokers allow their clients to invest in the Forex market on something called a ‘margin’.
This means that the broker will give the client a short term loan of up to 99% of the required total amount if the investor can come up with just 1% of the total. If this may sound too good to be true; it is. If all goes well, the investor as well as the broker come out of the deal smiling.
Understanding the Concept of Margin Calls
However, these deals can also go sour and result in what is called ‘margin calls’- not a very nice scenario for the investor. If you, as the investor wish to invest in euros in anticipation that it would rise against the dollar, you would need to pay the broker 1 % of the total cost you wish to invest; the broker puts in the balance 99%. If the euro gets devalued against the dollar in the ensuing days the broker may debate the wisdom of letting the investment ride. At some point if the broker decides that the money he has loaned you is at a high degree of risk, he can decide to make a margin call. This means that your investment will be sold off at lower than the buying price and you are obligated to make up to the broker for the loss he has suffered.
Tips & Strategies for Avoiding Margin Calls
Only deal with brokers you know and trust – While you do not have to be back-slapping buddies or intimate friends with your broker, it is important that you know enough about him to be able to trust him. Don’t make the mistake of trading in a good, trustworthy broker for a flashier one who promises you the moon; you could very well find yourself hearing far too many margin calls for comfort.
Maintain a healthy credit – Be realistic about your financial status and avoid jumping into the deep end of Forex trading using all your savings. Forex trading is too volatile for small players. If you absolutely must; make sure you only limit yourself to trading with money that you can afford to lose.
Keep an eye on the market – In fact keep both eyes on the market. Currency prices are extremely sensitive and will fluctuate quicker than you can imagine and with the huge sums involved, even a marginal fluctuation can result in an overwhelming loss.
If you intend trying your hand at Forex trading, the best advice you can get is to stay ever sharp and diligent in order to avoid getting crushed by margin calls.