However, the name is not so important. Regardless of the financial market, everyone should learn these concepts because the outcome of trading is highly dependent on the margin level.
What is margin trading?
Margin on a trade is the percentage of funds in a trader’s account that guarantees an open trade. In other words, forex margin is part of the funds required to start trading. If the margin used exceeds the margin size, the broker will not allow the margin to be opened.
The margin value determines the maximum leverage that can be used for trading. Therefore, trading with leverage is called margin trading.
Forex brokers primarily require margin to ensure that traders have the necessary self-funding to pay for their trades. The lower the leverage, the higher the required forex margin. And vice versa. In markets that trade with minimal leverage, margin requirements are usually determined by the amount deposited.
Margin calculation method
Forex Margin is part of the total funds in your account. Calculated using the following formula:
(volume (lot) x contract size (currency unit) x market price) / leverage
For example, you decide to buy one lot of the following product. euro dollar. The current exchange price is 1.1030 and the leverage offered by the forex broker is 1:100. In this case the formula would be:
Margin = (1 × 100,000 × 1.1030) / 100 = USD 1,103
Therefore, you need at least 1,103 USD in your account to start trading with this lot.
If you have insufficient funds in your account, you can solve the problem by increasing your leverage or decreasing your trading volume. Let’s increase the leverage to 1:500.
Margin = (1 x 100,000 x 1.1030) / 500 = USD 220
The amount of collateral required has been reduced by a factor of five. As trading volumes decrease, margin requirements decrease as well.
What is Free Margin?
The concept of free margin cannot be separated from the concept of margin. Free margin is the amount of funds in your margin account that are not involved in trading and are available for trading or withdrawals. In other words, Forex Free Margin is an indicator of the amount in your account that can be used to open additional trades. If there are no open trades on the account, the forex free margin equals the balance and equity.
Free margin is an important metric. Experienced traders use it only when absolutely necessary. When the forex market free margin approaches 0, the trading account is in danger. In this case, the broker may use margin calls to prevent losses.
Free Margin Calculation Method
Free Margin is the portion of funds that remain in your account after you start trading. It is calculated by the following formula.
Free Margin = Funds (Capital) – Margin
Let’s calculate the free margin when purchasing 1 lot. euro dollar. Suppose he has a trading account balance of USD 5,000. The current exchange price of the asset is 1.1030 and the leverage offered by the broker is 1:100. So the formula becomes:
Free Margin = 5,000 – 1,103 = 3,897 USD
This example shows how to calculate the free margin without considering open trades and other fees on the trading account. To get a more accurate value, we need information about open trades.
For example, before you start trading, you already have another open trading position, which brings you a profit of 100 USD. In this case, the capital indicator will not equal the trading account balance. Therefore, first of all we need to calculate the capital.
Funds (Equity) = Balance + Profit (or Balance) – Loss
Funds (Capital) = 5,000 + 100 = 5,100 USD
Free Margin = 5,100 – 1,103 = 3,997 USD
free margin example
Let’s use a real trading example to see where the margin and free margin parameters are displayed when trading forex.
1 – total assets or funds.
2 – Assets Used or Forex Margin;
3 – Available for operations or free margin.
You have opened a 1 lot EURUSD trade (see screenshot above). The leverage is 1:200, so the required collateral or forex margin is 552.37 USD. Since the trade is open and margin is used, it means there is also free margin. This is the 3rd metric and equals 3,888.16 – 552.37 = 3,335.80 USD.
margin level
In addition to the two main indicators, Margin and Free Margin, there is an additional indicator that shows the margin level. This is the ratio of account funds to margin expressed as a percentage.
In other words, margin level is the ratio of capital to deposit utilization. This is also called the maximum pile load. Margin level indicates how much open trades your trading account contains.
Let’s take the transaction and trading account parameters from the previous example.
Margin Level = (Equity (Equity) / Margin) x 100%
Margin Level = (3,888.16 / 552.37) × 100% = 703.904%
According to this calculation, we can conclude that the trading account is not so loaded and we can open a few more trades. However, if you lose money quickly, the rate will drop. The moment it reaches 100% means that the funds are equal to the margin. When that happens, you won’t be able to open any new trades, and you’ll immediately get a margin call. Remember to use stop loss to avoid this.
Margin Call and Stop Out
Margin calls were mentioned several times in the article. Let’s figure out what it is. In addition to margin calls, there are also stop-out levels. Beginners often confuse them, so I’ll explain the differences between them.
A margin call is a signal to the broker that a trader’s trading account is overloaded and the forex margin has reached a critical value. If you do not add free funds to your trading account, your open trades will be forcibly closed.
Stop-outs are used to force a broker to close a trade (starting with the least profitable trade) when the margin reaches a certain level. Once this operation is completed, the closed trade will release the margin. Closing a trade is complete if the indicator returns above the threshold.
Each broker has its own margin call and stopout levels. Traders should understand that brokers are putting their funds at risk by offering leverage. If you do not limit your losses in time, you may incur losses. To avoid reaching these levels, leave more free margin in your account.
Conclusion
A successful trader should clearly understand the difference between margin, free margin and capital. The result of the trade will greatly depend on this.
Margin in forex trading is the main risk indicator. The higher the margin, the less room you have to maneuver in an emergency.
Free Margin is an indicator of the operability of your trading account. The more free money you have, the more likely you are to be able to solve everything in a crisis situation.
Funds or Equity is a measure of the total amount of funds available in your account. If your trade is profitable, your capital will increase and your free forex margin will increase accordingly. In the event of a loss, the capital will be reduced and the amount of free margin will be reduced.
Frequently Asked Questions About Free Margins in Forex
Margin = (Volume x Market) / Leverage
The content of this article reflects the opinions of the author and does not necessarily reflect the official position of LiteFinance. The material on this page is provided for informational purposes only and shall not be considered as investment advice for the purposes of Directive 2004/39/EC.
