Trading on margin is a concept that was popularized in the financial markets as early as the inception of the stock markets. Trading on margin allows investors to hold on to larger positions in the market with a relatively smaller amount of trading capital, and in the Forex trading market, the phenomenon of using borrowed money to hold positions in the market is more commonly known as using leverage. Margin trading is considered to be a double-edged sword, as it can attract sizeable gains as well as significant losses.
Margin trading is highly popular in the Forex trading industry due to the extraordinary amount of leverage offered by brokers. Typical leverage in retail trading market starts from a paltry 1:5 to as high as 1:3000. Most brokers offer an average leverage in the range of 1:100 to 1:1000, however, CFTC rules stipulate that the maximum leverage available for US traders to be pegged at 1:50. So how does trading on margin affect the trading style of investors?
Forex Brokers With Interest Of Margin: Payable – How Leverage & SWAP Works
Trading on margin involves borrowing money from a lender to leverage one’s position in the market. The Forex market has a prescribed set of rules and limits regarding trading and has a particular set of limitations on how a trader can open a position in the market. In its pure form, Forex trading only allows traders to hold positions or market orders in multiples of standard lots. Therefore, to hold one standard lot on the EUR/USD currency pair in the market, a trader will be required to invest €100,000 or its equivalent of US Dollars according to the existing exchange rate.
In most cases, retail traders will find it hard to raise such a substantial amount of trading capital, which prevents them from holding any worthwhile positions in the market. Therefore, brokers allow their traders to enter the market with far less money by offering the option of trading on margin. For example, if a trader only has access to €1000, the broker may provide a leverage of 1:100 to enable the trader to leverage his position and buy or sell a standard lot of the EUR/USD currency pair. Of course, using such a high amount of leverage will induce wild swings in the profit and losses, as the trader is essentially holding a large position using a small trading capital.
A 1:100 leverage on a standard lot means that a trader is borrowing €99,000 on top of his own €1000 to open a position in the market. Irrespective of the outcome of the trade, a trader is fundamentally borrowing a staggering amount of money from his broker to hold a position in the market, which means that the broker is investing their money in a trade. Of course, the broker will employ minimum margin requirements and margin calls to protect their investments against market losses, which means that the trader will face a margin call if a position moves against him and the account equity reaches the minimum margin requirements. The minimum margin requirement varies according to the leverage used by the trader; therefore, a 1:100 leverage amounts to a minimum margin of 1%, while a 1:50 leverage amounts up to a minimum margin of 2%.
Since the broker is lending money to a trader to open a position in the market, they will require some fees or compensation for the money invested in the market. The broker might lend their own working capital to a trader’s position, or may alternatively rope in a lending institution such as a bank to increase the trading margin. Either way, trading on margin blocks the funds lent by the broker, which requires the trader to pay interest on the borrowed margin. The interest, or more commonly known as SWAP, is accrued for every overnight trade, as the interests are charged after the end of the New York trading session.
SWAP and interest rates are dependent on the currency pairs, which can result in both positive as well as negative SWAP. SWAP rates are determined by the base currency used for trading and the actual difference between the interest rates of the currency pairs invested in the market. For example, if a trader uses the US Dollar as the base currency to go long on the NZD/CHF (New Zealand Dollar vs. Swiss Franc), the SWAP rates are calculated by converting the USD to the CHF and then weighing up the NZD against the USD. Since the NZD has a stronger base rate (2.5%: at the time of writing this article) when compared to the negative rates of the CHF (-0.75%), traders going long (buying the pair) will enjoy a positive SWAP, while traders going short (selling the pair) on the pair will experience a negative SWAP.
Therefore, traders have the potential of making more money by going long on the NZDCHF pair by enjoying the positive SWAP as well as making money on any possible upward movement of the currency pair. Alternatively, if a trader shorts the NZDCHF, he will have to pay a negative SWAP fee or interest on his position, even if the market moves in his favor for potential gains in the market. SWAP rates are applicable for all traders who are trading on margin and typically hold their trades overnight.
Forex Brokers With Interest of Margin: Receivable – How To Earn Interest On Capital
More Forex Brokers Types
Some brokers offer traders the convenience of earning interest on unused capital in their trading accounts. Although retail traders mostly trade the markets using a small amount of trading capital, several professional as well as institutional traders are known to hold a significant amount of trading capital that may or may not be used for trading purposes. Under such circumstances, brokers offer a great incentive for such traders to earn interest on their unused capital to the tune of 2% to up to 10% per annum. Of course, the actual interests accrued on these accounts vary, but a few brokers sometimes offer higher returns to attract massive investments from wealthy traders.
A majority of retail Forex traders usually use up their entire capital for trading, and most of the accounts blow up within a few months of trading. Therefore, Forex brokers with interest on margin are offered for those investors who are looking for alternate ways of diversifying their investments. These interest-bearing accounts do have several limitations such as higher margin requirements and other trading conditions; therefore, traders should open an interest bearing account only after careful considerations of all the terms and conditions.
There are many ways by which traders can earn money in the markets without actually depending on the price movements in the market. Forex trading with interest on margin can either work by choosing currency pairs with a vast difference in their interest rates, or by investing a hefty sum of money in interest bearing accounts that pay well over the course of a year. Using an interest on margin strategy has been used by numerous Forex traders with consistently favorable results, but the average returns might not be as attractive as the results gained from successful investments in the Forex markets.