The simplest way to understand margin trading is it involves borrowing in order to increase the possible return of investment. Traders usually use margin accounts if they want to control a larger position by using the leverage of borrowed money.
Traders often also use a margin account when their own invested capital cannot control that large position.
However, the trader does not operate its margin account, their brokers do. Besides, margin accounts are also settled daily in cash.
How does it work?
To begin a margin trading, the traders interested to trade in the forex market should register themselves to either a regular broker or an online forex discount broker. After traders find a proper broker, then they need to set a margin account.
Once they have a margin account, then, the traders are taking a short-term loan from their broker. That loan is equal to the trader’s leverage amount.
Yet, the loan alone is not enough to let the traders start trading their margin accounts. They still need to deposit money into that margin account, first.
The amount of their deposited money depends on the margin percentage, they have agreed with their broker before. Usually, the margin percentage for every 100,000 currency unit ranges from 1% to 2%.
So, if a trader wants to trade $100,000, the 1% margin means that the trader needs to deposit $1000 into the account. Meanwhile, the broker provides the remaining 99%.
In a margin account, the broker usually will use the $1000 as a security deposit. If the investor’s position worsens and his or her losses approach $1,000, the broker may initiate a margin call. Then, if that happens, the trader needs to deposit more money or close out the position.
Also read: On Forex Trading, What Spot Market is
During this borrowed amount, the trader does not need to pay any interest. However, if the trader does not close their position before the delivery date or the final date when a forward contract should be delivered, then they may need to pay interest.
The interest will depend on the trader’s position and the short-term interest rates of the underlying currencies.