The ability to understand margin calls is a large part of finding success in the Forex market. In order to illustrate the concept, we have provided an example of a currencies trade.

Pairing the Euro with the US dollar we have:
Bid at 1.1901, Ask at 1.1903, Change of 0.0091, Percentage Change of -0.76%, High of 1.2024, Low of 1.1891, and the Time at 15:26.
A pairing of British pound and US dollar:
Bid at 1.7439, Ask at 1.7442, Change at 0.0004, Percentage Change of -0.02%, High of 1.7573, Low of 1.7410, and Time at 07:01.

In the first pair, an investor can buy one euro for 1.1903 dollars. To trade one lot of 100,000 units requires $119,030. In this case, the investor is speculating that the euro is undervalued in comparison to the dollar. After some time, the value changes to EUR/USD at 1.1966/68. The euros are sold for dollars at $119,660, so the profit equals $630. While this may not seem like a large amount, this trade can be duplicated several times in one week and takes less than 10 minutes time. The real profit lies in quantity; with a larger amount to invest, the profit will also be larger.

The Margin

Now let’s examine the margin on this transaction. Assume that the broker charges a 1% fee. The investor is expected to provide 1% of the transaction while the broker invests the remaining amount. So for this particular trade, the investor has spent $119.03 and was loaned the rest.

What is important to understand is that the broker is not an investor’s partner; if the trade results in a loss, the investor still must repay the entire amount of the loan to the brokerage firm. After the pair is closed, the investor repays the margin between his $119.03 and the remainder but he will also receive the entire profit of $630.

Losses From the Trade

Imagine that the above trade did not go as expected. For instance, the value of the euro could rise rather than decline. The euro could lose 3 pips (3/100) and fall to 1.1900. This could occur just as likely as the opposite scenario. If the broker decides to pull out of the investment, he will liquidate the investor’s position. The broker can sell the euros for dollars as requested and then close the trade, making a declaration for the investor without his prior knowledge or permission to do so.

The broker does not make money from a commission; rather he makes money from the spread. If an investor makes a bad trade, it costs the broker money as well. So in our scenario, the broker has invested $118,468.70 in the trade and when the euro decreases to 1.1900 he will lose $531.30. The investor is responsible for paying this loss to the broker.

It is simple to see how investing in currencies can produce a loss. The best defense is finding a good, trustworthy broker.