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Is FOREX Leverage a Money Maker?

There are generally three types of FOREX accounts that Forex traders use - a standard account, a mini account, or a micro account. In micro accounts,the FOREX trader trades in the smallest of sizes for lots, generally 1000 units of the base currency. The next step up is the mini account, which allows trades in lot sizes of 10,000 units of the base currency. The standard FOREX account allows trades in 100,000 units of the base currency, and is the level at which youll find all professional FOREX traders.

The nice thing about having three levels of investment minimums is that it allows new FOREX investors to get their foot in the door without having large amounts of investment capital before they can get started. Micro accounts allow traders to deposit as little as $250, and due to the power of leverage, lets the FOREX trader control sums of currency many times larger than their investment capital.

Although FOREX leverage provides investors with a method of generating healthy profits it can also be responsible for the new FOREX investor losing his or her capital very quickly. The primary reason new FOREX traders fail is that theyre undercapitalized for the type of account theyve opened. Professional traders understand this, and this is why they make sure they have far more investment capital to deposit in their FOREX account than the required minimum.

Leverages constant companion is the margin. Margin basically describes the amount of money in your account that you can use to conduct trades. The amount of usable margin you have to play with is dictated by the amount of equity you have in your account: take the equity in your account and subtract the amount of margin that youve used and youve got your usable margin.

If the equity in your account ever drops below the amount of used margin then a margin call is generated. A margin call is when the broker cashes in enough of your position to cover the drop in equity. As an example imagine that you have $10,000 in your account, giving you $10,000 in usable margin. You buy $7000 worth of lots, giving you $3000 remaining in usable margin. If the value of your investment drops just a few pips (which can easily occur in a matter of hours or minutes in some cases) your equity can drop from $10,000 to $7000 quite quickly. At this point the margin call is triggered and you lose $3000 to cover your margin. Before you know what has happened youve lost 30% of your investment capital.

The power of FOREX leverage can be seen in the above example. The ability to control $100,000 worth of currency with $1000 can catapult the savvy FOREX investor into the next tax bracket, but only if they manage their margins wisely.

With the FOREX market being such a volatile place, those who do not understand the concept of margins will quickly fall victim to it. So leverage is a double edged sword. Those that understand this reality are far better equipped to succeed in the FOREX market than those who jump in unprepared.

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