[B]Hi, red ear[/B] (by the way, how did you get that screen name?)
Since you are a self-confessed total newbie, let me tell you two things.
First, if some of this forex stuff is hard to grasp at first, don’t beat yourself up about it. We’ve all been there. We all started out as newbies, and had to grapple with new concepts, and a bunch of math, in order to understand this market.
You’re on the right path: you’re studying the BabyPips School; and when you need additional help, you’re asking questions. Congratulations for being one of those who go about this the right way.
Second, your link will undoubtedly get deleted by the Mod’s, because you have to have 50 posts to your credit before you’re allowed to post links. So, I’ll repeat your link here, where it won’t get deleted, so people can see what you’re referring to. Here’s the link:
Margin Calls: Example of a Forex Currency Trading Margin Call
Now, on to your questions. Here are the short answers:
[B]1.[/B] Yes. In the example, no change in price occured (and the initial loss represented by the spread was ignored).
[B]2.[/B] Ignore the 100:1 leverage for right now (we’ll talk more about that in a minute). In the example, the spy put on a position consisting of 80 mini-lots. Because the USD is the cross-currency in this example, the value of 1 pip = $1/mini-lot, which is $80 on an 80-mini-lot position. That’s $80 profit if the price rises 1 pip, and $80 loss if the price falls 1 pip. In the example, the price falls 25 pips. So, 25 pips x $80/pip = $2,000 loss.
Maybe you’re not quite clear on one or more of the following points:
The word “leverage” has two different meanings: (1) maximum allowable leverage, as determined by your broker, and (2) actual leverage used, as determined by you. In the example of the spy, the broker allowed a maximum of 100:1 leverage. But, the position put on by the spy was 80:1, because he bought 80 mini-lots with a $10,000 account. 80 mini-lots x 10,000 units of currency per mini-lot = 800,000 units. 800,000 units / $10,000 = 80:1.
Maximum allowable leverage, and margin, are two sides of the same coin. 100:1 maximum allowable leverage = 1% margin required = $100 margin required / mini-lot — because 1% of a $10,000 mini-lot is $100.
The margin required, each time the spy places a trade, will be $100 per mini-lot, regardless of how much leverage he actually uses. It might help you to think of margin as a security deposit which your broker requires you to post, and to imagine that this security deposit is actually deducted from your account and placed in an escrow account. You will get it back, when your position is closed. So, in the case of the spy, he bought 80 mini-lots, the broker took $8,000 “out of his account” for margin, which left the spy with only $2,000 to cover losses.
The example omitted the spread to simplify the explanation. If we put the spread back into the calculation, the spy’s transaction goes like this:
He buys 80 mini-lots. $8,000 of his money gets “escrowed”, leaving $2,000 Usable Margin, to cover losses.
The spread [B](which is an initial loss that he starts out with)[/B] gets subtracted from Usable Margin —
that is, 3 pips/mini-lot x 80 mini-lots x $1/ pip = $240 subtracted from Usable Margin to cover the spread.
Usable Margin now equals $1,760.
If the price now moves against the spy, each pip costs him $80 in Usable Margin. If the price moves 22 pips against him, all of the $1,760 is wiped out, and the broker automatically closes all of his 80 mini-lot position.
He now gets his $8,000 margin back, but he has taken a $2,000 loss ($240 due to the spread + $1,760 due to the adverse price move). His Account Balance is now $8,000. He has just blown 20% of his account — possibly in a matter of minutes.
Study these relationships, until you are able to explain them fully to another newbie.
By the way, we are all newbies. Some newbies are just “newer” than others.
Clint
