The forex market utilizes margins to increase profits.
Forex is a nickname for foreign exchange, which is a vast market for trading where the commodity is money itself. In the forex market, traders buy and sell foreign currencies, such as trading dollars for euros, pounds for yen, and so forth.
Forex is profitable because national currencies fluctuate daily based on predictions of the nation's gross domestic product and other factors. As with the stock market, the goal of forex is to buy low and sell high. For instance, buying a lot of a particular currency when it's weak and selling it when it becomes stronger.
For example, bad financial news in Great Britain means that forex traders will sell their British pounds as quickly as possible as the pound is about to become devalued. Once the pound recovers, these traders will sell it for something else, thus turning a profit.
Although we use the terms "buying" and "selling" pounds, euros, yen, and francs, the transactions performed in the forex are not literal. That is, if you want to buy 100,000 euros, you don't have to withdraw the equivalent U.S. dollars from your bank account and swap them for a big stack of euros. Everything is done on paper only, although the resulting profits and losses are real.
Because the transactions are not physical, there is room in the forex for what are called "margins" or "leverage." This means you don't have to put up the full amount of the position you're taking. Usually, the margin is 1%, meaning that when you put $1,000 into it, you're actually getting $100,000. However, margins multiply your losses as well as your profits, so you need to be careful.
One reason for allowing a 100:1 margin is that the major world currencies in the forex market usually fluctuate less than 1% a day. (In the stock market, a typical stock might fluctuate as much as 10% in one day.) With changes that small, your daily loss or gain on an initial investment of $1,000 would be almost imperceptible, usually less than $10 either way. By multiplying it by 100, the gains and losses in the forex market are more pronounced.
With leverage implemented that way, the basic "lot" for buying and selling currencies is usually 100,000 (which costs only $1,000). Most firms that handle day trading on the forex market don't go any lower than that.