Historically, currencies were traded in specific amounts called lots. The standard size for a lot is 100,000 units. There are also mini-lots of 10,000 and micro-lots of 1,000.
To take advantage of relatively small moves in the exchange rates of currency, we need to trade large amounts in order to see any significant profit (or loss).
|Lot||Number Of Units|
As we have already discussed in our previous article, currency movements are measured in pips and depending on our lot size a pip movement will have a different monetary value.
What is Leverage & Margin?
Trading with leverage allows traders to enter markets that would be otherwise restricted based on their account size. Leverage allows traders to open positions for more lots, more contracts, more shares etc. than they would otherwise be able to afford.
Let’s consider our broker a bank that will front us $100,000 to buy or sell a currency pair. To gain access to these funds they ask us to put down a good faith deposit of say $500 which they will hold but not necessarily keep. This is what we call our margin. For each position and instrument we open our broker will specify a required margin indicated as a percentage. Margin can therefore be considered a form of collateral for the short-term loan we take from our broker along with the actual instrument itself.
For example, when trading FX pairs the margin may be 0.5% of the position size traded or 200:1 leverage. Other platforms and brokers may only require 0.25% margin or 400:1 leverage.
The margin requirement is always measured in the base currency i.e. the currency on the left of the FX pair
Let’s look at an example. Say we are using a dollar platform and we wanted to buy a micro lot (1,000 units) of the EUR/GBP pair and our broker was offering us 200:1 leverage or 0.5% required margin.
Our broker will therefore take just €5 as margin and we were able to buy 1,000 units of the EUR/GBP pair. If we were using a US Dollar platform that €5 is automatically converted to dollars by our broker at the current exchange rate for the EUR/USD.
|Trade Size||1,000 Units|
|Margin Requirement (Leverage)||0.5% (200:1)|
|Used margin for Trade||€5 (or $6.75 @ EURUSD rate of 1.3500)|
Say we wanted to sell 50,000 units of the USD/ JPY and we are using a Euro platform and our broker was offering us 400:1 leverage or 0.25% required margin. Our broker will therefore take $125 from our balance as our margin requirement and we are able to sell 50,000 units of the USD/JPY.
This time we are using a Euro platform so that $125 is converted to euro at the current EUR/USD exchange rate.
|Trade Size||50,000 Units|
|Margin Requirement (Leverage)||0.25% (400:1)|
|Used Margin for Trade||$125 (or €96 @ EURUSD rate of 1.3000)|
When an FX position (or a CFD position) is held overnight (or ‘rolled over’) there is a charge known as a ‘swap’ or ‘overnight premium’. We call it a charge; however it is possible to earn a positive sum each night too. When trading FX, it is based on the interest rates of the currencies we are buying and selling.
So for example, if we were buying the AUD/CHF we would earn a positive overnight sum as we would earn interest on the Australian Dollars we bought as the Australian interest rate is higher than the Swiss interest rate (in fact the Swiss interest rate is zero). So often buying currencies against the Swiss Franc will result in a positive swap.
For the most part however an overnight premium will be a charge on our account and again this relates to the size of our position. The actual percentage is very small each night as it is the annual interest rate divided by 360 (days in year). Our broker automatically calculates overnight premiums and they usually take effect after 10pm GMT.
Under the trading conditions most brokers will stipulate the swap rates for a buy or sell position on each pair. We multiply this rate by our trade size and divide by 360 like the formula above to know what premium we are charged or we earn.
|FX Pair||Premium Buy (Rate per annum)||Premium Sell (Rate per annum)|
Above are examples of various swap rates for a sample of FX pairs. We can see that the overnight premium can be positive or negative and depends on whether we are buying or selling the pair. It is important to review the premiums if we plan to leave positions open overnight as it will affect the profit or loss of our position. All brokers should outline their overnight rates under their trading conditions.