Have you been wondering if you should take part in margin trading in Forex? This kind of trading involves borrowing funds and using this to invest further. The money borrowed is called the margin. In the Forex market, margin trading can allow you huge leverages.
With this, you will be able to control trades much larger than the funds you have in your account. Does it sound complex? Read ahead to find your questions about margin trading answered.
What is Margin Trading?
In general terms, margin trading refers to a process where investors trade to buy more stocks than they can afford. Several stockbrokers provide this service. The securities that you can purchase while margin trading include bonds, options, derivatives, and stocks.
For the most part, margin traders need to have a part of the funds needed to invest themselves. The remaining part can be borrowed. Do note that margin in Forex trading and securities trading can be very different things.
Many financial authorities can define the rules that margin traders in security have to adhere to. In the US, the Financial Industry Regulatory Authority (FINRA) set the initial margin or the amount to be borrowed at 50% of the value of the purchase. For instance, if you are looking to invest $10,000, you should have at least $5000 on you.
In Forex trading, the margin simply refers to an amount that must be kept in the account as you leverage your trade. This has been explained in detail below.
This is what margin trading fundamentally is. However, there are several layers to this trade that you can understand better as you read ahead. Before you begin trading, it is important to become familiar with a few terms that dominate the world of margin trading.
These have been explained below.
Margin Account
To begin margin trading, you must have a separate account that can hold your trading funds and any securities you purchase. This is called the margin account.
You cannot use a regular cash account or standard brokerage account as they are called. All the securities or Forex that you buy on margin will remain in this account.
In Forex, margin accounts are used to leverage trade. This enables a trader to be able to control a larger part of the market share than he can with his own money.
Initial Margin
To begin margin trading, you will have to prove that you have an initial margin in your account. This refers to the funds that should be there in your account that determine whether the broker will lend to you.
According to the FINRA, this initial margin is 50% of the value of the securities you are purchasing. Many other brokers will have their specific requirements. Note that this is the amount that needs to be present in the margin account.
Forex brokers online require you to deposit a good faith initial margin deposit to be able to deal with currencies. Further, a 1% initial margin is also offered by many Forex brokers. This means that you can control as much as $100,000 with an initial margin of $1000.
Maintenance Margin
This is the amount of your own money that needs to be in the margin account following the purchase of securities. According to FINRA, this is about 25% of the value of the securities that you have purchased. Other brokers require more.
Do note that this maintenance margin is not a static figure. As the value of your securities increases or decrease, so does the amount of money you need to keep in your margin account. In Forex, the same is expressed through equity, and Floating L/P is explained below.
Margin Calls
This is a call to you by the broker, suggesting that the maintenance margin in your account is falling below the required level. If you don’t replenish the funds, the broker may liquidate your securities. You must treat margin calls seriously as you are alerted.
In the Forex market, the broker may simply close out the position on behalf of the trader if the maintenance margin is not maintained.
What is Account Balance?
The account balance is different for Forex accounts and securities. Under securities, there are two accounts for investors who are looking to purchase securities. These are cash accounts and margin accounts. Each has a different requirement in terms of monetary funds and the available balance.
In Forex, a margin account will allow leveraging, and this is crucial to trade. You will have to first open an account to begin trading on a forex platform. You will have to wait for your account to be approved before you can start funding it.
Do note that this is a risky business. Hence, the account can be funded only with risk capital. These funds can be subject to losses. These funds form the basis of your account, which is called the account balance.
In general, it is the amount of cash that you have deposited into your account. If you have deposited $2000 in your Forex account, this amount is your balance. Do note that any trade that you open does not affect your account balance.
It is only affected if you incur any losses or gain profits. These will reflect in your account balance once the trade has been closed. For traders who hold positions for more than one day, swap fees may be added or deducted from the account balance depending on their trade.
This may affect account balance. Know that these swap fees are small, but if you keep positions overnight often, this may add up to deduct a hefty fee from your account balance. Keep an eye on these as you trade.
Unrealized P/L and Floating P/L
In Forex, there exists unrealized P/L that is also called the Floating P/L. These are seen on trading platforms and have green and red numbers beside them. P and L stand for profit and loss. There are two types of them as you trade.
Unrealized P/L is a dynamic figure and constantly changes in a moving market. For this reason, it is called the Floating P/L as well. It simply refers to the profit that you would have gained or loss you would have incurred if you closed your trading position at a point in time.
It refers to your profit or loss position at that point. This does not mean that you either profit from it or incur a loss. It is simply a concept used to define your current trading position.
Do note that in an Unrealized P/L, all your open positions will have to be closed immediately. The value for this keeps changing across time. Consider that you currently have an unrealized loss. If the market suddenly moves in your favor, you will have an unrealized profit at your end.
The concept has to do with potential and hope, and calculating it can help you stay away from any uncalculated trading moves. Here’s how you can calculate your Floating P/L.
Consider that you bought 100 EUR/USD units for 1.15000. Now the current exchange rate maybe 1.12000. The Unrealized P/L can be calculated by using the following formula.
Unrealized P/L = Currency Units x (Present Price – Price bought at)
Unrealized P/L = 100 x (1.15000 – 1.12000)
Upon calculating, this would be 3 pips. If each pip is worth $1, then you would have a Floating loss of $3.
Do note that the figures used above are only hypothetical, and Forex trading accounts often require higher amounts to be invested in trade. In this example, if the market price was above 1.15000 for the EUR/USD pair, the investor would face an Unrealized profit.
When the position is Unrealized loss, a trader hopes that the market shifts to show a profit. In this case, he may choose to close the trade or wait for the market to get better.
Do note that Unrealized P/L does not reflect any changes in your account balance. This happened only in the case of Realized P/L when you or the broker closes the trade.
What is Margin?
When trading in Forex, a margin simply refers to the amount of money that a trader needs to put in to complete a trade. For a margin, a trader will require an initial margin or a small fund of capital outlay.
Various brokers have their margin requirements. In the UK, the most popular currency pairs require a margin of about 3.3%. This means that you require 3.3% of the value of these currency pairs as you trade. The rest of the amount can be borrowed or leveraged from the broker. This can be as much as 96.7%.
Now, if you are investing in a position that is worth $10,000, a margin requirement of 3.3% would mean that you need to invest just $330 to complete the trade. This is called the margin.
However, do note that trading on margin can be a tricky thing to master. You will be working with huge borrowed funds. If you attain profits, they will likely be very large. However, any losses incurred will also be just as large.
That being said, there are several Forex brokers that allow you to open an account by depositing just $200 and with a leverage of 30:1. This lets you trade huge amounts on margin.
While margin trading, there are several terms that you should familiarize yourself with. These have been outlined below.
What is a Used Margin?
In Forex trade, every position that you occupy will have something called the required margin. This is the margin required to leverage the trade depending on the value of the currency pair you are opening trade on.
From our previous example, for a 3.3% margin rate on a position worth $10,000, the margin will be $330. This is the required margin. Traders often have several positions open at a given point in time. The sum of the required margins of all these positions is called the used margin.
To keep all of your trades open, you will need a used margin deposit available in your margin account at all times.
Why is this figure important? It is simply because you won’t have access to your used margin amount. You cannot use this to open any new trades. Hence, it is the locked up amount.
Here’s an example. Consider that you’ve deposited $2000 in your account and want to open a trade on any two currency pairs. Both have a margin requirement of 3.3%. Also, assume that each trade is worth $10,000.
With this in mind, the required margin for the first open position is $330, and the same stands for the second open position. Now, if you add these up, you will get $660. This is the sum of all your required margins and is called the used margin.
Of the $2000 that you deposited, $660 is now locked up, and you cannot use it to open new trades. You will now have $1340 available to open any new trading positions.
What is Equity?
Now that you know what your used margin is, you can understand equity in margin trading better. The account equity, also simply called equity, represents the current total value of the margin trading account that you have.
Because the value in a Forex market is guided by currency pairs, the value of your account can also be represented in currency values. Hence, the equity keeps fluctuating in the dynamic Forex market.
Here, the concept of Unrealized P/L or Floating P/L becomes relevant. It is because your current equity also takes into account all your open trades. This is why the fluctuations in equity occur.
Hence, equity is the sum of the total amount in your account and all your Unrealized P/L at any given point in time. As your Unrealized P/L changes, so do your equity.
Now, if you have no trades open, your equity is simply equal to your account balance. If you have a trade open, simply add your account balance and the sum of all your pending Floating P/L.
Your account balance and equity are the same if you do not have any open positions. If you do, the difference between account balance and equity is as much as the Floating P/L.
What is Free Margin?
It is important to understand the concept of equity to be able to gauge what free margin means. There are two kinds of margins available. One is the free margin, and the other is the used margin.
As discussed above, the used margin refers to the sum of all the required margin from every opening position you may have. Free margin is the difference between equity and the used margin.
This is the amount that is not locked up in any particular open trade. Hence, the trader is free to use it. Another frequent name used for free margin is the usable margin. It is called so because this amount is usable.
When you think of usable or free margin, there are two ways to articulate it. It is either the amount that is available to a trader such that they can open new positions. It can also be defined as the amount that the other open positions move against your favor so that you receive a margin call or stop out the order.
Here’s a formula so that you can go ahead and calculate your free margin or usable margin.
Free Margin = Equity – Used Margin
Hence, do note that if your open positions are moving in your favor, you will have that much more free margin that you can use. This is if you have a Floating profit in your open positions.
Now, if you have floating losses, this will decrease your equity. Hence, your free margin decrease, as well. If you have no floating P/L, your free margin will be the same as your equity.
Here’s how you can calculate your free margin if you have an open position. Say, for instance, that you want to make a trade worth $10,000. The margin requirement is 3%. In this case, the required margin would be $300.
If you have no other trade open, your used margin will be equal to $300. Let’s say you have a total of $2000 in your account. Of this, $300 is your used margin.
What will your equity be? Let’s say you have a Floating profit of $100 at a point in time. At this point, your equity would be equal to the account balance plus the Floating P/L.
This would then be $2000 + $100, which would equal $2100. The free margin would simply be your equity minus the used margin. This would then be $2100 – $300, which is $1800. Hence, at that specific point of Floating profit, your free margin would be $1800.
As your Floating P/L changes, so will your equity and your free margin.
What is Margin Level?
You now know what used and free margins refer to. These are essential to understand what is called the margin level.
To simply put it, the margin level is a ratio. It refers to the percentage derived based on the total equity versus the used margin. Why is this level important? It simply lets you know whether you can engage in new trade and how much of your funds you can use on this.
If your margin level is high, it means that you have more funds to trade with. If it is low, the less free margin, you have to open any new trades.
If your margin level becomes very low, it can result in a margin call or stop out. These have been discussed in detail below.
If you want to know your margin level, you have to take into account the fluctuations in the market. This is especially true if you already have any trades open, as this will reflect in your equity. Here is the formula for the margin level.
Margin level = (Equity/Used Margin) x 100%
You won’t have to go to the length of calculating your margin level each time. Your trading platform will do this for you and display it to you. Have you been wondering what may happen to your margin level if you have no trades open?
It will simply be zero. You may also wonder why the margin level is important when there are other indicators like equity. This is because this percentage gives a quick glance at the health of your account and enables you to make prompt decisions if you need to.
It will also let you know just how close you are to the broker’s margin level limits. Brokers have their limits. However, many of them use 100% as the margin level. At this point, your equity and used margin will be just equal.
What does this mean for your trade? If your equity is less than or equal to the used margin in your account, you cannot open any new positions. If you still want to open a new position quickly, one of the options you have is to close an older position and create some free margin for yourself.
Here’s an example. Now after calculating the required margin for a trade, let’s say that your required margin is $300. If you have no other trades open, your used margin and required margin will be the same figure of $300.
Let’s assume that your Floating P/L is at a breakeven position at a point in time. This would mean that it is zero. Hence, if your account balance is $2000, your equity would equal this plus Floating P/L.
This would be $2000 + $0, which would be $2000. Now you know that your equity is $2000, and the used margin is $300. Now you can calculate the margin level.
This would be (equity/used margin) x 100%.
Hence, (2000/300) x 100%. This would be 666.6%. Do note that for most trading platforms, anything above 100% should be a margin level on which you can open trades.
What is a Margin Call Level?
We have briefly discussed this above to get an idea of what margin trading can mean. Here is an in-depth description of a margin call level in Forex trade.
The margin call level refers to a threshold. You will find this margin call in several different types of trade. In Forex, if you reach the margin call level, the broker may close all your positions or liquidate them without you directing them to do so.
You have previously read what the margin level is. The broker can pick any particular margin level and label it the margin call level. Many forex brokers use a margin call level of 100% below, which they may force close your positions.
However, you won’t have to keep checking your margin level to see if it has touched the margin call level. This can be beneficial but not necessary. This is because most brokers give traders what is called a margin call when their percentage falls below the margin call level.
In Forex, historically, this margin call was an actual phone call. This is where it derives its name from. However, of late, many forex traders simply operate online. Hence the medium for the call has also diverted to just be a call or an email at most.
How can you determine when you will receive a margin call? At this point, your Floating losses will be greater than your Used Margin. These floating losses reduce equity to bring them to a figure lesser than the used margin, hence causing the margin level to fall below 100%.
You should also know that the margin call and the margin call level are two different concepts that cannot be confused. The best way to remember them is by taking due note of the last word in each phrase.
Margin call has the word ‘call’ as its last word. This means that it simply means an event where you receive a notification. On the other hand, the margin call level has ‘level’ as its last word. It suggests that it is a level or a percentage where your used margin exceeds your equity. You can even calculate it yourself without any notification.
Why can you not open new positions if you enter the margin call level? This is because the losses in your open positions continue to fall, hence affecting your equity even more. What you can do is simply close all your open positions.
Now, to continue trading, you will have to bring your equity level higher than your used margin. You can do this by depositing more funds into your account. If this is not an option, close all your open positions.
What Is a Stop Out Level?
Once you reach the margin call level, what if your trade still continues to incur losses? You may simply be waiting in the hope that the market turns upwards and in your favor. However, this may not always happen, and your margin level may fall further.
The stop out level is simply another level that automatically alerts your broker. A stop out level is very similar to a margin call level. However, it means that you will face worse consequences than you would have in a margin call level.
The stop out level is also called the automated stop out level. At this point, your margin level falls to a point where all of your open positions are automatically closed by the brokering platform.
This means that there is a lack of margin and your positions have to be liquidated. In technical terms, the stop out level is a position where your equity is lower than your used margin.
Will all of your open trades be shut down arbitrarily? No, most brokers use a specific logic. They begin by first shutting down your least profitable trade. After this, your other trades are shut based on their profit levels. This is done only until your margin level is above the stop out level.
You may want to note that this automated closing at stop out level may be beneficial to your trade. It is because you can keep an eye on the level to prevent further losses for yourself. You can close the trade if you find yourself approaching the stop out level.
This level is also beneficial as it will prevent you from incurring any further losses. Do note that you won’t be able to tamper with a stop out process. Since it is automated, once the liquidation process has begun, it will continue.
Disclaimer: The Margin Call Level and Stop Out Level of Each Broker May Be Different
If you are just planning on entering the Forex market with a margin account, you may have several brokers in mind. As you look into their various features, make sure to look into their margin call level and stop out level. Yes, this is crucial.
It is not a good idea to simply jump into trading without knowing this. Yes, 100% is the most common margin call level out there. However, it may not be the same for others. Do note that some brokers simply consider the margin call level and stop out level as one and the same.
What does this mean for you? If this is the case, know that you won’t receive a margin call. Instead, at the stop out level, your open positions will automatically be liquidated. Some other brokers differentiate clearly between a margin call level and a stop out level.
Hence, once you reach the margin call level, they give you a margin call. This is a warning that the stop out level is approaching. For instance, a particular platform may have a margin call level of 100% and a stop out level of 20%.
When you are at 100%, you will receive a margin call. If you touch 20%, your open positions will be liquidated. Do note that any positions closed will be executed at the best available price.
Use this margin call before stop out to put your affairs in order and close any trades that may be moving against you.
What is the Relationship Between Margin and Leverage?
So far, you have heard the term margin and leverage being used increasingly. Read ahead to find out more about the relationship between the two.
Are margin and leverage the same? They are inter-related concepts but not the same. Leverage is created by using margin. This comes through creating a margin account. With this account, you can use the initial margin to create leverage.
Leverage will allow you to trade amounts that are much higher than the margin that is available in your account. Note that this leverage is expressed as a ratio. It is simply the difference between the amount of money that you have in your account to the amount that you can trade.
You can express leverage by quoting it in the ‘X:1’ format. How can you calculate the leverage that your trading platform provides you for each currency pair? Simply divide the amount that you want to trade by the margin requirement your platform asks of you.
If you are making a trade worth $10,000 for a USD/CAD pair, say that your platform requires a margin of 10%. This would mean that you need an initial margin of $1000. Dividing these, you know that the leverage for the pair is 10:1.
Note that the figures above are hypothetical and have no bearing on real-time trading figures.
A simple formula can help you find the leverage depending on the margin requirement.
Margin requirement = 1/leverage ratio
From the above example of 10% leverage, this would be
- = 1/leverage ratio
Leverage ratio = 1/0.1
This is then 10:1. Now you know two ways of getting to the leverage ratio. Through this, you know that the margin requirement and leverage ratio have inverse relationships.
Your Cheat Sheet for Margin Jargon
You have taken a look at all the popular terms that make the margin account in Forex tick. It can be difficult to remember all of this in a go. Here is a cheat sheet to help you put your best foot forward.
Margin
Margin simply refers to the amount that is required to maintain and open trades in the Forex market. Different brokers define different margin levels. It is simply used as collateral so that you can cover the losses that trading may make you incur.
Unrealized P/L
This refers to the potential profit or loss that your open positions will incur in the market at any given point in time. It is also called Floating P/L.
Leverage
Having leverage simply means that you are trading large sums with a small percentage of this value in your account.
Balance
This refers to the total funds that you have in your account. This will not include any Floating P/L. This is also referred to as account balance or cash.
Margin Requirement
This is defined per position and is the percentage of the value of your position that you must deposit in your account before you open the trade.
Required Margin
This is defined by the margin requirement and is simply the cash amount that is kept in the account. It cannot be used for any other trade. It is also called the initial margin.
Used Margin
This refers to the sum total of all your required margins from all the open positions you hold. It is also called the Maintenance Margin Required (MMR).
Equity
This refers to the sum of your account balance and any the Floating P/L of all your open positions at a given point in time.
Free Margin
If you subtract your used margin from the equity, you arrive at the free margin. This is the amount with which you can open new trades. It is also called the usable margin.
Margin Level
The ratio between equity and the used margin is called the margin level. As a percentage, it expresses the health of all your trades.
Margin Call Level
Most brokers set this at 100%. It is generally equal to or below that level at which equity equals used margin in a margin level. Brokers give you a margin call at this point to warn you.
Stop Out Level
Some brokers treat the margin call level and stop out level as the same. This simply means the position at which your margin level is low enough for the broker to force close all your open positions and liquidate them.
How to Avoid a Margin Call?
The best way to avoid a margin call is to understand it. By knowing how margin levels work and how you can slip to a margin call level, you can keep track of any negative movements in the market that may affect your account. Being alert can help you avoid a margin call.
It is also a good idea to ensure that you know just what the margin requirements for each order are. Once you do this, don’t wait for the limit indicators provided by the broker to guide you. Actively monitor the margin levels yourself to take action before you get a call.
Use a stop-loss order or even a trailing loss. Make sure to see if your platform offers you this. If it does, use it to track any potential losses and stop it before it reaches the margin call level.
Pay attention to risk management as well. Use indicators and scaling positions to guide you through your trade. This can prevent you from making any hurried trades that may lead to huge leveraged losses.
Endnotes
In the Forex trade, margin trading can let you control a huge market share by using only a small margin. However, to prevent any losses from this, it is important to understand the key terms that are associated with margin trading and margin accounts.
By using these and the provided cheat sheet, you will be well on your way to making informed trading decisions as a margin trader.
Learn more about margin trading by opening a demo account. No need to risk your money anymore with IC Markets or eToro.