Lot size in trading Forex. Leverage and risk. Margin.

Lots - quantity you want to trade

  1.0 Lots  = 100,000 units of currency ( 1 Lots )

  0.1 Lots  =   10,000 units of currency ( 1 mini-lots )

0.01 Lots  =     1,000 units of currency ( 1 micro-lots )

All with up to as much as 1000:1 being available (although not in the US where the maximum is now 50:1 after a ruling by the CFTC).

Leverage

In finance, leverage (sometimes referred to as gearing in the United Kingdom) is a general term for any technique to multiply gains and losses. Common ways to attain leverage are borrowing money, buying fixed assets and using derivatives.  

Leverage and risk
  

The most obvious risk of leverage is that it multiplies losses. A corporation that borrows too much money might face bankruptcy during a business downturn, while a less-levered corporation might survive. An investor who buys a stock on 50% margin will lose 40% of his money if the stock declines 20%.

There is an important implicit assumption in that account, however, which is that the underlying levered asset is the same as the unlevered one. If a company borrows money to modernize, or add to its product line, or expand internationally, the additional diversification might more than offset the additional risk from leverage. Or if an investor uses a fraction of his or her portfolio to margin stock index futures and puts the rest in a money market fund, he or she might have the same volatility and expected return as an investor in an unlevered equity index fund, with a limited downside. So while adding leverage to a given asset always adds risk, it is not the case that a levered company or investment is always riskier than an unlevered one. In fact, many highly-levered hedge funds have less return volatility than unlevered bond funds, and public utilities with lots of debt are usually less risky stocks than unlevered technology companies.


source: http://en.wikipedia.org/wiki/Leverage_%28forex%29#cite_note-autogenerated1995-0
 

Margin
 

In finance, a margin is collateral that the holder of a financial instrument has to deposit to cover some or all of the credit risk of their counterparty (most often their broker or an exchange).
 

This risk can arise if the holder has done any of the following:
  •     borrowed cash from the counterparty to buy financial instruments,
  •     sold financial instruments short, or
  •     entered into a derivative contract.

The collateral can be in the form of cash or securities, and it is deposited in a margin account. On United States futures exchanges, "margin" was formerly called performance bond. Most of the exchanges today use SPAN (Standard Portfolio Analysis of Risk) methodology for calculation of margin in 'Options' and 'Futures'. SPAN was developed by the Chicago Mercantile Exchange in 1988.



Types of margin requirements


The current liquidating margin is the value of a securities position if the position were liquidated now. In other words, if the holder has a short position, this is the money needed to buy back; if they are long, it is the money they can raise by selling it.

The variation margin or maintenance margin is not collateral, but a daily payment of profits and losses. Futures are marked-to-market every day, so the current price is compared to the previous day's price. The profit or loss on the day of a position is then paid to or debited from the holder by the futures exchange. This is possible, because the exchange is the central counterparty to all contracts, and the number of long contracts equals the number of short contracts. Certain other exchange traded derivatives, such as options on futures contracts, are marked-to-market in the same way.

The seller of an option has the obligation to deliver the underlying of the option if it is exercised. To ensure they can fulfill this obligation, they have to deposit collateral. This premium margin is equal to the premium that they would need to pay to buy back the option and close out their position.

Additional margin is intended to cover a potential fall in the value of the position on the following trading day. This is calculated as the potential loss in a worst-case scenario.

SMA and Portfolio margin offer alternative rules for US and NYSE regulatory margin requirements.

Enhanced leverage is a strategy offered by some brokers that provides 4:1 or 6:1+ leverage. This requires maintaining two sets of accounts, long and short.


Example 1
    An investor sells a call option, where the buyer has the right to buy 100 shares in Universal Widgets S.A. at 90¢. He receives an option premium of 14¢. The value of the option is 14¢, so this is the premium margin. The exchange has calculated, using historical prices, that the option value won't go above 17¢ the next day, with 99% certainty. Therefore, the additional margin requirement is set at 3¢, and the investor has to post at least 14¢ + 3¢ = 17¢ in his margin account as collateral.

Example 2
    Futures contracts on sweet crude oil closed the day at $65. The exchange sets the additional margin requirement at $2, which the holder of a long position pays as collateral in her margin account. A day later, the futures close at $66. The exchange now pays the profit of $1 in the mark-to-market to the holder. The margin account still holds only the $2.

Example 3
    An investor is long 50 shares in Universal Widgets Ltd, trading at 120 pence (£1.20) each. The broker sets an additional margin requirement of 20 pence per share, so £10 for the total position. The current liquidating margin is currently £60 in favour of the investor. The minimum margin requirement is now -£60 + £10 = -£50. In other words, the investor can run a deficit of £50 in his margin account and still fulfil his margin obligations. This is the same as saying he can borrow up to £50 from the broker. 


source: http://en.wikipedia.org/wiki/Margin_trading

Best Regards,  
^^_Lord_Ice_^^

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