Hi all, thanks in advance for your time. I’m currently in the early stages of learning how to trade forex on a Demo Account and I’m just looking for some guidance to confirm I am on the right track in my learning if possible?
My account is in GBP with a 500:1 leverage.
(Which from my understanding, if I had say a £100 account. £100 x 500 = £50,000 but i struggle to understand why and how i could control that amount of money with such a small account size?
I understand a 0.01 lot = 10p Per Pip = £1000 worth of currency controlled.
A 0.10 lot = £1 Per Pip = £10,000 worth of currency controlled.
And a 1.00 lot = £10.00 Per Pip = £100,000 worth of currency controlled.
However, I’m struggling to understand why I can control such large amounts of money based on my account size.
I understand Leverage is a trade size multiplier, where the broker lends additional capital without any money changing hands.
I know because the market moves in such small amounts (One, 100th of 10p) we need to magnify the trade size to make any real money.
To to confirm my understanding -
1/100th of a decimal on 10p is 0.01
1/100th of a decimal on £1 is 0.10
1/100th of a decimal on £10 is 1.00
I struggle to understand why I can control £1000, £10,000 and £100,000 based on these lots?
Please can someone be willing to help and explain to help me understand why?
Any help and guidance will be greatly appreciated, thank you
Like most newbies struggling to learn this business, you are confused about the nature of retail forex trading. And it’s not your fault. Much of the so-called “teaching” you will find on the internet is misleading, at best, or – worse – just plain wrong.
Let’s discuss what’s going on, and what isn’t going on, in a typical retail forex trade.
Your account is denominated in GBP. So, let’s start with that, and let’s take a look at a one-mini-lot EUR/GBP trade. It doesn’t matter whether this hypothetical trade is long or short. I’m using the EUR/GBP pair for this example, because the quote currency (GBP) matches your account currency.
In your post, you said that pips are worth 10p per micro-lot, £1 per mini-lot, and £10 per standard lot. That is true ONLY for the EUR/GBP pair. In all other GBP pairs, the GBP is the base currency, not the quote currency, and the pip-values in those pairs differ from those round numbers, above.
In the one-mini-lot EUR/GBP trade in our example, each pip will be worth £1.
Let’s say that you have £500 in your account — more than enough money to cover the required initial margin on a one-mini-lot EUR/GBP trade.
The notional amount of your trade is 10,000 units (one mini-lot) of EUR/GBP. The notional value of your trade is €10,000 (the base currency in this pair). At the current EUR/GBP exchange rate (EUR/GBP = 0.8771), the notional value of your trade in GBP is £8,771 (€10,000 x £0.8771 per €).
Let’s talk about what you have done, and what you have not done, up to this point.
What you have done in opening this trade
You have just placed a “bet” on the future change in the GBP-value of a certain quantity of EUR. The quantity involved here is the notional amount (10,000 units of EUR), and its value in GBP is the notional value calculated above – £8,771.
You have placed this bet with your broker, who now has the other side of your bet. In forex-speak, we say that your broker is your counterparty in this trade. If you took a long position, your broker now holds an equivalent short position. And vice versa.
You can think of the size of your bet as being your risk in pounds-sterling, and you can think of your odds in this bet as being the R-value of your trade. For example, if your stop-loss is 30 pips away from your entry price, then your risk – and therefore the size of your bet – is 30 pips x £1/pip = £30. If your take-profit is 60 pips away from your entry price, then you are attempting a 2R trade. Your theoretical odds are 2:1, and your anticipated profit is £60.
Your “odds” above are referred to as “theoretical”, because in forex – unlike other forms of betting – there is more than one possible winning outcome. You could exit your winning trade at any point prior to reaching your take-profit, in which case your closed trade would be less than 2R, and your profit would be less than £60. Compare this to betting on a horse-race. If you bet a particular horse to win, he either wins the whole race, or not. You can’t cash your ticket half-way through the race, for one-half of a full payout, just because your horse is ahead at the half-way point.
The notional value of your position will change, as the price of EUR/GBP fluctuates or trends. And those changes in the notional value will represent either profit or loss in your account, depending on the direction that the EUR/GBP price moves.
The bet you have placed is on the direction and extent of that price move.
Because you are exposed to the possibility of loss in this trade, your broker requires that you have funds available in your account. If you are very careless, or very unlucky, you could lose all of your account, except for a small portion which your broker has set aside, out of your reach. This small portion is called margin, and it’s purpose is to salvage the last shred of your account in the event of a devastating wipe-out, and to prevent your account balance from going negative (in which case, you would have lost all of your money, and you would be starting to lose some of your broker’s money).
Typically, two margin amounts – initial margin and maintenance margin – apply to every trade. Initial margin is related directly to the stated maximum allowable leverage on your account. In your example, leverage of 500:1 corresponds to required initial margin of 2/10 of 1% (0.002) of the notional value of your trades. In the EUR/GBP example above, initial margin would be 0.002 x £8,771 = £17.54. That’s the absolute minimum amount you must have in your account, in order to open the EUR/GBP trade in our example.
After your trade is opened, that initial margin is replaced by maintenance margin, which is typically 50% of the initial margin amount, i.e. £8.77. That tiny amount is the portion of your account that cannot be consumed in losses. If your account were to be decimated down to that level, your broker would automatically close your position, leaving your account open with a balance of £8.77
What you have not done in opening this trade
(1) You have not bought or sold any currencies (despite what many sources will tell you!).
(2) You have not been “in control” of €10,000, or £8.771, or any other sum of any currency – except the equity in your account. Recall that “equity” is your account balance before your trade was opened, plus (or minus) unrealized profit (or loss) in your open trade.
(3) You have not placed a €10,000 bet, or an £8,771 bet. As mentioned above, you have bet the amount of your risk, not the notional value of your trade.
(4) You have not gone head-to-head with some other retail trader who took a position exactly opposite to yours. Your bet is with your broker, not with another trader, and not with the overall market.
(5) Lastly, you probably have not influenced the actual foreign currency market, at all – not because your trade was insignificantly small, but because it was most likely offset by a market-maker (either your broker, or an ECN), before ever reaching the actual (interbank) market.
Hi Clint, apologies in my delay in replying. I’m very grateful that you have been kind enough to take the time to help me understand my query. I have a much better understanding now, and will continue your post further
