Forex Risk

Trading off-exchange foreign currencies is a challenging and potentially profitable opportunity for educated and experienced investors. However, before deciding to participate in the Forex market, you should carefully consider your investment objectives, level of experience and risk appetite. Most importantly, do not invest money you cannot afford to lose.

There are also risks associated with utilizing an internet-based deal execution software application including, but not limited, to the failure of hardware and software and communications difficulties.

The Forex Market is the largest and most liquid financial market in the world. Since macroeconomic forces are one of the main drivers of the value of currencies in the global economy, currencies tend to have the most identifiable trend patterns. Therefore, the Forex market is a very attractive market for active traders, and presumably where they should be the most successful. However, success has been limited mainly for the following reasons:

Many traders come with false expectations of the profit potential, and lack the discipline required for trading. Short term trading is not an amateur's game and is not the way most people will achieve quick riches. Simply because Forex trading may seem exotic or less familiar then traditional markets (i.e. equities, futures, etc.), it does not mean that the rules of finance and simple logic are suspended. One cannot hope to make extraordinary gains without taking extraordinary risks, and that means suffering inconsistent trading performance that often leads to large losses. Trading currencies is not easy, and many traders with years of experience still incur periodic losses. One must realize that trading takes time to master and there are absolutely no short cuts to this process.

The most enticing aspect of trading Forex is the high degree of leverage available. MB Trading Futures, Inc offers traders 100 to 1 margin leverage. Leverage seems very attractive to those who are expecting to turn small amounts of money into large amounts in a short period of time. However, leverage is a double-edged sword. Just because one lot (10,000) of currency only requires $100 as a minimum margin deposit, for US Dollar based currencies (USD/JPY), it does not mean that a trader with $1,000 in his account should be easily able to trade 10 lots. Our technology only allows a trader to trade sizes that he/she can afford at that moment.

Case Scenarios:
When a trader opens a position, the trader must have the buying power to allow for the opening of the position.  Please refer to the following:

US Dollar Based Pair:  Client available buying power must be greater than or equal to the size of the trade.

Example: Client deposited $1,000.00.  Margined buying power of $100,000.00 would not be able to open a position of 110,000 USD/JPY.  However, the client could open a maximum number of 100,000 or a standard lot of the USD/JPY or any other US Dollar based currency pair. 

Non-US Dollar Based Pair: Client available buying power must be greater than or equal to the market value of the currency position. 

Example: Client has deposited $1,000.00.  Margined buying power of $100,000.00 would not be able to open a standard lot size or 100,000 GBP/USD.  If the GBP/USD was offered at 1.9726, then this would require an available buying power greater than or equal to 197,260.00.  Based on a market rate of 1.9726, the client could purchase a maximum number of 5 mini lots of GBP/USD, using up $98,630.00 of his buying power.

Exotic Currency Pair:  Client available buying power must be great than or equal to the market value of the base pairs relationship to the US Dollar. 

Example: Client has funded his account with $1,000.00.  Client wants to open the maximum number of lots available in the GBP/JPY.  Client must take into consideration the price of the base currency’s (GBP in this case) relationship to the US Dollar.  In this case client would refer to the rate of the GBP/USD.  With this being said, client could open a maximum number of 5 mini lots of the GBP/JPY.   

Margin Policy:  MB Trading Futures, Inc (MBTF) margin policies dictate that at any time a trader has an open position he/she must maintain a minimum of 20% equity. MBTF will make every effort to contact you in regard to risk position(s), however in some instances if your account declines too quickly, the order desk will liquidate partial or entire open position(s) at risk to bring your margin equity percentage to 40%.

1. To determine the equity percentage calculation, we must first understand the requirements for US Dollar vs non-US Dollar based and exotic currency pairs.  The margin requirement for each of these currency pairs is as follows:
2. US Dollar Based (I.E. USD/JPY): 1% of the trade size. If we were to purchase 100,000 USD/JPY, the margin debit would be $1,000.00.
3. Non-US Dollar Based (I.E. GBP/USD): 1% of the market value. If we were to purchase 100,000 GBP/USD at 1.9850, the market value equates to 198,500, which will create a margin debit of $1,985.00. A margin call would occur at 20% of $1,985 or below $397.
4. Exotic Currency Pair (I.E. GBP/JPY): Margin requirement is determined by the base currency's relationship to the US Dollar. Therefore, opening a position in the GBP/JPY the margin requirement is that of a non-US Dollar based currency pair or GBP/USD.

If we were to purchase 100,000 GBP/USD at 1.9650 this would equate to a market value of 196,500. Therefore, the margin debit requirement would be $1,965.00.

Exotic Currency Pair (I.E. GBP/JPY): Margin requirement is determined by the base currencies relationship to the US Dollar.  Therefore, opening a position in the GBP/JPY the margin requirement is that of a non-US Dollar based currency pair or GBP/USD.

Once we are able to determine the margin debit requirement for opening a position in a foreign currency, we then need to understand how to determine your margin equity percentage.  When you open a position, based on the performance of that position, your account value will fluctuate.  However, as long as you don’t add or open a new position, your margin debit requirement will remain the same.

1. With this being said, refer to the following formula to determine your margin equity percentage, if there are no open positions within the account:
2. Account Value / Margin Debit = Margin Equity Percentage

Now let us look at an example, if you funded your account with $1,000.00.  This would merit your account an available buying power of $100,000.00.  In this example, we purchase 5 mini lots of the USD/JPY.  Based on our previous lesson we would determine that the margin debit requirement for those 5 mini lots of the USD/JPY, would equate to $500.  To determine this margin debit we would use the following formula:

50,000 X 1% = 500.00 or $500.00

Once we’ve determined our margin debit for the 5 mini lots of the USD/JPY, we would then want to determine what our current account equity percentage is?  To determine your margin equity percentage, we must assume that the bid price is at our long basis.  Keep in mind that when we establish a long position the bid price change is going to influence our running profit and loss.  In addition, we would deduct the transaction cost from our account value.  To open 5 mini lots of the USD/JPY the transaction cost will be $2.50 for the entry.  Based on these descriptions, our current account value would be $997.50.  With this information we can now determine our current account equity percentage:

997.50 / 500 = 199.50%

How can I determine if I am going to receive a margin call?

The above example conveys that our account is far from being in a margin call situation.  However, how can we determine at any time what our account value will have to go down to, to incur a margin call?  To determine the account value which would generate a margin call liquidation:

Margin Debit X 20% = $_____ which would trigger margin call liquidation.

In our example, $500 margin debit X 20% = $100.00.  So if your account value of $997.50 declined to $100.00 remaining account value, then you can expect an adjustment to your open position size to bring your account equity percentage to 40%. 

We understand that these concepts are extremely important to properly manage your risk.  An investor may decide that when his account equity falls to 40%, to automatically send in more funds to the account to assist in sustaining the open position.  

1. There is considerable exposure to risk in any foreign exchange transaction.  Any transaction involving currencies involves risks including, but not limited to, the potential for changing political and/or economic conditions that may substantially affect the price or liquidity of a currency.  Moreover, the leveraged nature of Forex trading means that any market movement will have an effect on your deposited funds proportionally equal to the leverage factor.  This may work against you, as well as for you.  The possibility exists that you could sustain a total loss of initial margin funds and be required to deposit additional funds to maintain your position.  If you fail to meet any margin call within within the time prescribed, your position will be liquidated and you will be responsible for any resulting losses.  Investors may lower their exposure to risk by employing risk-reducing strategies such as ‘stop-loss’ or ‘limit’ orders

So what does this all mean to me?

Let us try and keep these lessons as clear and simple as possible.  Prior to opening a currency position we need to determine if we first can afford the trade.  Once we determine if we can afford the trade, we then submit the order.  Once the position is established the client will see a value for margin debit within the Account Balances window in the MBT Navigator program.  Once we determine the Margin Debit value, we can use our formula to determine at what account value a margin call will incur.  In initiating this formula, you may want to set a conservative rule of if your account equity drops to 35%, then you are going to wire more funds to your account to sustain the open account risk.  Lastly, when we see that our account value is equal to the value of our margin debit, you can assume that at that time your account equity percentage is in excess of 100%. 

MB Trading Futures, Inc cannot stress the importance of understanding the risks of trading foreign currencies and how important it is to be able to properly manage your account and associated margin risk.  In addition, we suggest that you also refer to the NFA’s publication “Trading in the retail Off-Exchange Foreign Currency Market – What Investors Need to Know” to fully understand all risks associated in trading off-exchange forex products.  If you have any questions please feel free to contact our support staff at 1-866-558-3342.