When borrowing money from your broker, it gets referred to as ‘trading on margin. You do this to increase your exposure on the market. Your broker will borrow the money, and the amount will depend on the leverage ratio that gets used, and the collateral is a portion of your trading account. This is also known as margin for that trade. Along with margin is: what is free margin in Forex, indicated on your trading platform.
What is Free Margin?
What is remaining in your account will act as the free margin. These funds are necessary to withstand the potential unfavourable fluctuations from your leverage positions or to open new leverage trades if you want.
Calculating Free Margin
So, we know that free margin in Forex is the sum of your trade balance accessible for opening new spot positions on margin.
To calculate free margin, it is equity minus used margin:
Let’s say the equity is $9,250 and the used margin is $3,250, you will calculate the free margin as:
$9,250 – $3,250 = $6,000
Equity is the total account balance and the unrealized profits and losses from open positions. The account balance is the total money deposited in your trading account. If there are no trades open, then your equity is equal to your trading account balance.
Before we begin, let’s calculate equity:
Calculating equity is easy if you don’t have any open positions.
Equity = account balance + floating profits (or losses)
$1,000 = $1,000 + $0
Your balance is, therefore, the same as your equity. You don’t have any floating profits or losses as there are no open positions.
For example:
Your trading account has a balance of $1,000, and your margin is 10%. You now want to open a position that costs $6,000. When you open the trade, it will look like this:
- Account balance = $ 1,000
- Margin = $ 600 (10% of $6,000)
- Equity = $1,000
- Free Margin = $400 (Equity-Used Margin)
Let’s say the value of your position increases, and there is an unrealized profit of $40; we can establish the following:
- Account Balance = $1,000
- Margin = $600
- Equity = $1,040
- Free Margin = $440
The used margin and the account balance did not change, although the free margin and equity have increased to show the open position’s unrealized profit. Keep in mind that if the position had decreased in value by $40, then the free margin and equity will decrease by $40.
What is FX Margin Level?
The Forex Margin Level is a percentage that demonstrates the ratio between equity and used margin. It can get calculated as:
Margin Level = (Equity / Used Margin) * 100
Brokers will use margin levels to see if Forex traders can or can’t take new positions. If the margin level is 0%, it means that the open account doesn’t have any open positions. If the margin level is 100%, the account equity is equal to the used margin. The broker will then expect you to add more money to your account if you want to make more trades. If your unrealized profits increase, you can add more trades.
Calculating the Margin Level
The calculation for the margin level is as follows:
Margin level = (Equity / Used Margin) x 100 %
The platform you use to trade should automatically calculate your margin level. Your margin level will be 0 if there are no open trades. Many brokers will set the limit at 100%, which means that the equity is equal to or less than the used margin, and you cannot open any new positions. If you intend on opening any new margins, you will need to close some positions first.
For example:
If your equity is $4,000 and the used margin is $1,000, your margin level is 400%.
What is FX Margin Call?
A margin call is when you receive a notice from your broker that your margin level has dropped below a specific threshold. The threshold gets referred to as the margin call level.
There’s a difference between brokers with the margin call level, but they still occur before having to resort to a stop-out. You get warned that the market is moving against you, and you need to act appropriately. Brokers warn you to avoid scenarios where the trader can’t afford to have their losses covered.
It is essential to remember that if the market moves fast against you, your broker may not be able to make the margin call before it reaches the stop level.
You can avoid the margin call by monitoring your account balance regularly. You can also use stop-loss orders on each position you create. Be sure to implement a risk management plan within your trading endeavours. When you manage your risk, you are more equipped to anticipate and avoid them.
Conclusion
Traders may argue that if you have too much margin or too little free margin, it can be dangerous. Although, it will depend on your style of trading and experience. If the margin level is high – the higher your free margin is for you to trade. It can be a profitable Forex strategy to trade on margin as long as you understand the risks involved.
If you choose to use the Forex margin, you must know precisely how your account operates. Read the margin agreement between your broker and yourself and if there is something that you don’t understand, ensure that everything gets clarified.