Trading on margin is the practice of borrowing money to amplify the size of a position using initial capital as collateral. In Forex, brokers provide leverages as high as 200:1. Leverage is a powerful tool to deal in the market when properly utilized. However, such a powerful tool in the hands of a poorly trained individual would cause the total destruction of his trading capital. Think of it as using bombs to dig up a tunnel saving time and effort, when used irresponsibly, those bombs could turn against you. We have covered the basic idea behind leverage now we'll apply that to the kind of leverage Forex brokers offer. An interesting feature in trading currencies is that compared to what stock brokers offer of twice the account's trading capital, Forex brokers provide their clients a lift of up to 200 times the amount of their trading capital. Looking at this buying $10,000 worth of Euros could be done with just $70, yes it is possible but that amount would leave no room for volatile price changes.
Trading a mini lot (10,000) of EUR/USD has a pip value of $1. That pair has
a spread of 3 pips meaning you're already down $3.00 as soon as you hit that
buy order. Now if you only have $100 in your account, your position would be
stopped out if the price would move 27 pips down leaving no room for recovery
since the margin is too tight.
Let's assume that two traders with $2,000 each in trading capital opened up an account going long on the Euro against the US dollar (EUR/USD). Here are the terms,
Lot size Margin
Required Pip value
EUR/USD 1 $70 $1
EUR/USD 10 $700 $10
Trader A ordered 1 Lot of EUR/USD, and trader B took 10 lots, both entered at the same rate at 1.4130.