Wednesday, April 29, 2015

Leverage,Rollovers , Accounts and Statements

Leverage is financed with credit, such as that purchased on a margin account which is very common in Forex. A margined account is a leverageable account in which Forex can be purchased for a combination of cash or collateral, depending what your brokers will accept.
The loan (leverage) in the margined account is collateralized by your initial margin (deposit). If the value of the trade (position) drops sufficiently, the broker will ask you to either put in more cash or sell a portion of your position or even close your position.
Margin rules may be regulated in some countries, but margin requirements and interest vary among brokers/dealers so should always check with the company you are dealing with to ensure you understand their policy.
Up until this point you were probably wondering how a small investor can trade such large amounts of money (positions). The amount of leverage you use will depend on your broker and what you feel
comfortable with. There was a time when it was difficult to find companies prepared to offer margined accounts, but nowadays you can get leverage from as low as 1% with some brokers. This means you could control $100,000 with only $1,000.
Typically the broker will have a minimum account size, also known as account margin or initial margin e.g. $10,000. Once you have deposited your money, you will then be able to trade. The broker will also stipulate how much they require per position (lot) traded.
In the example above, for every $1,000 you have, you can take a lot of $100,000. So if you have $5,000 they may allow you to trade up to $500,000 of forex.
The minimum security (Margin) for each lot will vary from broker to broker. In the example above the broker required a one percent margin. This means that for every $100,000 traded the broker wanted $1,000 as security on the position.
Margin call is also something that you will have to be aware of. If for any reason the broker thinks that your position is in danger e.g. you have a position of $100,000 with a margin of one percent ($1,000) and your losses are approaching your margin ($1,000). He will call you and either ask you to deposit more money, or close your position to limit your risk and his.
If you are going to trade on a margin account it is imperative that you talk with your broker first to find out what their policies are on these types of accounts.
Variation Margin is also very important. Variation margin is the amount of profit or loss your account is showing on open positions
Let's say you have just deposited $10,000 with your broker. You take 5 lots of USD/JPY, which is $500,000. To secure this the broker needs $5,000 (1%).
The trade goes bad and your losses equal $5001, your broker may do a margin call. The reason he may do a margin call is that even though you still have $4,999 in your account the broker needs that as security and allowing you to use it could endanger yourself and him.
Another way to look at it is this: if you have an account of $10,000 and you have a 1 lot ($100,000) position. That's $1,000 assuming a (1% margin) is no longer available for you to trade. The money still belongs to you but for the time you are margined the broker needs that as security.
Another point of note is that some brokers may require a higher margin during the weekends. This may take the form of 1% margin during the week and if you intend to hold the position over the weekend it may rise to 2% or higher. Also in the example we have used a 1% margin but this is by no means standard. I have seen as low as 0.5% and many between 3%-5% margins. It all depends on your broker.
There have been many discussions on the topic of margin and some argue that too much margin is dangerous. This is a point for the individual concerned. The important thing to remember, as with all trading, is that you thoroughly understand your broker's policies on the subject, that you are comfortable with them and understand your risk.
Even though the mighty US dominates many markets, most of Spot Forex is still traded through London in Great Britain. So for our next description we shall use London time. Most deals in Forex are done as Spot deals. Spot deals are nearly always due for settlement two business days later. This is referred to as the value date or delivery date. On that date the counter parties theoretically take delivery of the currency they have sold or bought.
In Spot FX the majority of the time the end of the business day is 21:59 (London time). Any positions still open at this time are automatically rolled over to the next business day, which again finishes at 21:59.
This is necessary to avoid the actual delivery of the currency. As Spot FX is predominantly speculative, most of the time the traders never wish to actually take delivery of the currency. They will instruct the brokerage to always rollover their position.
Many of the brokers nowadays do this automatically and it will be in their policies and procedures. The act of rolling the currency pair over is known as, which stands for tomorrow and the next day.
Just to go over this again, your broker will automatically rollover your position unless you instruct him that you actually want delivery of the currency. Another point worth noting is that most leveraged accounts are unable to actually deliver the currency as there will be insufficient capital there to cover the transaction.
Remember that if you are trading on margin, you have in effect used a loan from your broker for the amount you are trading. If you had a 1 lot position your broker will have advanced you the $100,000 even though you did not actually have $100,000. The broker will normally charge you the interest differential between the two currencies if you rollover your position. This normally only happens if you have rolled over the position and not if you open and close the position within the same business day.
To calculate the broker's interest he will normally close your position at the end of the business day and again reopen a new position almost simultaneously. You open a 1 lot ($100,000) EUR/USD position on Monday 15th at 11:00 at an exchange rate of 0.9950
During the day the rate fluctuates and at 22:00 the rate is 0.9975. The broker closes your position and reopens a new position with a different value date. The new position was opened at 0.9976 - a 1 pip difference. The 1 pip difference reflects the difference in interest rates between the US Dollar and the Euro.
In our example you are long Euro and short US Dollar. As the US Dollar in the example has a higher interest rate than the Euro you pay the premium of 1 pip.
Now the good news - If you had the reverse position and you were short Euros and long US Dollars you would gain the interest differential of 1 pip. If the first named currency has an overnight interest rate lower than the second currency, then you will pay that interest differential if you bought that currency. If the first named currency has a higher interest rate than the second currency, then you will gain the interest differential.
To simplify the above - If you are long (bought) a particular currency and that currency has a higher overnight interest rate, you will gain. If you are short (sold), the currency with a higher overnight interest rate, then you will lose the difference.
I would like to emphasize here that although we are going a little in-depth to explain how all this works, your broker will calculate all of this for you. The purpose of this book is just to give you an overview of how the forex market works.
Although the movement today is towards all transactions eventually finishing in a profit and loss in US Dollars, it is important to realize that your profit or loss may not actually be in US Dollars.
As you would expect, and also from my observations, this trend is more pronounced in the US. Most US based traders assume they will see their balance at the end of each day in US Dollars. I have even spoken with some traders who are oblivious to the fact that their profit might have actually been in Japanese Yen.
Let me explain a little more. You sell (go short) USD/JPY and as such are short USD and Long (bought) JPY. You enter the trade at 116.10 and exit 116.90. You in fact made 80,000 Japanese Yen (1 lot traded) not US Dollars.
If you traded all four major currencies against the US Dollar you would in fact have made or lost in EUR, GPY, JPY and CHF. This might give you a ledger balance at the end of the day or month with four different currencies
This is common in London. They will stay in that currency until you instruct the broker to exchange the currencies into your own base currency.
This actually happened to me. After dealing with mainly US based brokers it had never occurred to me that my statement would be in anything other than US Dollars.
This can work for you or against you depending on the rate of exchange when you change back into your home currency. Once I knew the convention I simply instructed the broker to change my profit or loss into US Dollars when I closed my position. It is worth checking how your broker approaches this and to simply ask them how they handle it. A small point, but worth noting.
Nowadays most countries have regulated forex, but it is still worth checking that the broker who you are dealing with is regulated in the country that he operates. Check that he is insured or bonded and has some kind of track recorded.
I cannot advise you on which broker you should use as there are just too many variables to each person, but as a rule of thumb, nearly all countries have some kind of regulatory authority who will be able to advise you. Most of the regulatory authorities will have a list of brokers that fall within their jurisdiction and they will give you that list. They probably won’t tell you who to use, but at least if the list came from them you can have some confidence in those companies.
Once you have a list, give a few of them a call, see who you feel comfortable with, ask them to send you their polices and procedures. If you live near where your broker is based, go spend the day with him. I have been to many brokerages just to check them out. It will give you a chance to see their operation and meet their team.
This brings up another interesting point. When you open an account with a broker you will have to fill in some forms that basically state your acceptance of their polices. This can range from a single page document to something resembling a book. Take the time to read through these documents and make a list of things you don't understand or need explained.
Most reputable companies will be happy to spend some time with you on this. Your involvement with your broker is largely up to you. As a forex trader you will probably spend long hours staring at the screen without talking to anyone. You may be the sort of person who likes this or you may be the sort of person who likes to chat with the dealer in the trading room. You will normally get a call once a week or once a month from someone in the brokerage asking if everything is OK.
Before we move on to account statements I just want to touch on segregation of funds. In times past there was a danger that traders who deposited money with a broker who did not segregate their clients money from their own companies money were at some risk.
The problem arose if the broker misused the deposited funds to either reinvest or manipulate these deposits to enhance their own standing. There were also instances were the broker became insolvent and many complications ensued as to what was the clients money and what was the broker's money.
With the advent of regulation most brokers now segregate their client’s funds from the brokerage funds. Deposits are normally held with banks or other large financial institutions that are also regulated and bonded or insured. This protects your money should anything happen to your broker.
The deposit taking institution is normally aware that these deposits are client's funds. Depending on regulation in the particular country in which you live, each client may have their own segregated account or for smaller depositors, they may be pooled. The point is that segregation of funds is a safeguard. Ask your broker if your funds are segregated and who actually has your money.
Just as with a bank you are entitled to interest on the money you have on deposit. Some brokers may stipulate that interest is only payable on accounts over a certain amount, but the trend today is that you will earn interest on any amount you have that is not being used to cover your margin.  Your broker is probably not the most competitive place to earn interest but that should not be the point of having your money with him in the first place. Payment on your account that is not being used and segregation of funds all go to show the reputability of the company you are dealing with.
In this section I will discuss briefly the basic account statements. I have to keep this basic because as you can imagine, there are many flavors of account statements.
Just about every broker has their own way of presenting this. The most important thing is to know where you stand at the end of each day or week. Just because your broker is Internet based and has all the bells and whistles does not mean that they are infallible.
Many of the actions taken before information is imparted are still done by hand, and if human beings are involved, there will be a mistake at some point. The responsibility lies with you. It is your money so make sure that all the transactions are correct.

 Normally there is a ticket or docket number to help identify the trade. You will nearly always find the time/ date of the trade and the value date if the currency was to be delivered. You should always see the direction of the trade, buy or sell (Long or Short), the amount and rate at which you bought or sold. Balance will let you know if you made a profit or a loss.
You should also see any open positions you may have and the margin requirements for that position. A lot of the more modern systems will show your open position as though it has been closed just to give you an up to the minute balance.


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