Margin and Lots
Forex is traded is lots, which is the minimum amount of currencies you have to trade. A lot is US$100,000 worth of currency. Many market maker brokers now make mini-lots available for people with smaller trading accounts. A mini-lot is US$10,000.
Margin trading is simply the term used for trading with borrowed capital. This is how you're able to open US$10,000 or US$100,000 positions with US$50 or US$1,000. You can conduct relatively large transactions, very quickly and cheaply, with a small amount of initial capital. If the broker offers 100/1 leverage (1% margin), you need US$1000 in your account to take one position (buy or sell 1 lot) of currency (worth of US$100,000). For mini-lots, you only need US$100.
For Example: You believe that signals in the market are indicating that the British Pound will go up against the US Dollar. You open 1 lot ($100,000) for buying the Pound with a 1% margin (leverage 100/1) at the price of 1.5000 and wait for the exchange rate to climb. This means you now control $100,000 worth of British Pound with $1,000. Your predictions come true and you decide to sell. You close the position at 1.5050. You earn 50 pips or about $500. (A pip is the smallest price movement available in a currency). So for an initial capital investment of $1,000, you have made 50% return. Return equals your $500 profit divided by your $1,000 you risked to trade. We will discuss about the value of a pip in later section.
A final note on margin: your brokerage account balance is monitored while you are trading, and if you should get into a trade with minimal margin and then have the trade start to lose, there is a minimum $ value (usually 10% of the margin required to get into the trade) at which the trading desk will exit all your trades and take you out of the market. (This is assumed that you do not have any STOP LOSS in place). You can not lose more money than you put in to your brokerage account.
For Example: You have a mini-account where US$100 controls US$10,000. If your have $1,000 in your account and were to buy 10 lots, and the trade went against you to the point where you open loss was $900. Your usable margin would be reduced to $100. Then, if the price dropped further and dropped your account to a penny below $100 (10% of the initial margin to hold those positions), your market maker broker would automatically close all your open positions. This is for your protection.