Forex Trading Example with Margin
Let’s say you have a negative view on the pound versus the dollar and opt to sell sterling. You would do this by going short on GBPUSD.
In our example, the mid-price is 1.4076, and you choose to sell £100,000. The initial margin required to place this trade is £1,000 (100:1). GBPUSD is quoted four places after the decimal point, meaning each ‘pip’ is worth $10.
To reflect the true risk, we must convert this to dollars – 1.4076 x £1,000 = $1,407.60.
The leverage/margin requirement changes in tandem with the fluctuations in the exchange rate.
So, if GBPUSD were to rise to 1.4200, the margin required to maintain this trade would be 1.42 x £1,000 = $1,420.00. By this time, the trade will be losing you $1,240 (124 pips at $10 each), effectively knocking that amount off your margin base. In this scenario, you would only have $180 of margin left.
In this case, you may be required to deposit more funds in your account to cover the trade – what’s called a margin call.
Let’s look at the same base case, selling £100,000 at 1.4076 but this time the pair moves in the direction you hope for.
GBPUSD drops to 1.4000 and you close the trade, delivering a profit of 76 x $10 = $760, or £543 ($760 at the new exchange rate of 1.4000).
In simple terms, you sold £100,000 at 1.4076 = $140,760 and bought it back cheaper at a rate of 1.4000 to swing a £543 profit from just a £1,000 deposit. That’s a profit margin of over 50% on your initial outlay. Without leverage, you’d still have made a profit, but it would only have been £5.43 from your £1,000 stake.