What is Margin in Forex?
What is margin in Forex and how to avoid receiving a dreaded margin call.
Margin is the capital that your broker requires you to have available in your trading account to open a leveraged position. Think of margin in Forex as the deposit that your broker holds as collateral when you take a leveraged position much larger than your account could otherwise control.
Many new Forex traders think of margin as a cost, but this isn’t actually the case. Margin in Forex is nothing more than a security deposit that allows you to trade a much larger leveraged position and ensures that you can cover your losses if the position moves against you. Don’t worry, it’s returned to your account when the position is closed.
If you’re a trader who’s taking advantage of the leverage offered by your broker, then you’re required to understand what is margin in Forex. We’ve broken down the margin, provided some example trades and offered real tips to avoid being margin called below. If you have not already, read our guide on what is Forex trading.
Key Forex Margin Trading Definitions
When you look at the terminal window inside your MT4 platform, you’ll notice there are a range of terms relating to margin that you’re going to need to understand. These are key platform insights you need to understand.
- Equity: Equity is the total, live balance of your Forex trading account. It includes both closed and open trades, so if you have a position that’s currently $1000 in profit, then you’ll see that reflected in your equity with $1000 on top of your closing balance.
- Used Margin: Used Margin is the margin that’s been locked up as collateral by your broker. This means that used margin can’t be used again to open a new position because it’s already in use.
- Free Margin: Free Margin is the amount of margin not already locked up and free to use when opening a new trade. This is easily worked out by subtracting the used margin from your equity.
- Margin Level: Margin level is a simple view of how much of your account is still available to be used for opening new positions. It’s shown as a percentage and based on your equity v used margin.
Example Forex Margin Trades
Now we know the key Forex margin trading definitions, it’s time to put our theory into practice and go over a couple of example margin trades. It is important to understand how does Forex trading work.
Margin Trade Example 1 – Free Margin Available
In our first example, we’re going to go over a trade that leaves a large portion of our margin untouched as free margin.
Let’s say that we have a $10,000 trading account and open a number of trades that our broker requires $2,000 of margin to keep open. This would place our used margin at $2,000 and free margin at $8,000.
We have learned that we want to keep our margin level high in order to continue opening new trades on our account and our margin level would be worked out by using the equation: ($10,000 / $2,000) x 100 = 500%.
You can see that as we’re above 100%, we still have a free margin buffer and are therefore trading well within the bounds set by our Forex broker.
Margin Trade Example 2 – Margin Call
In our second example, we’re going to feature a reckless trade where we use up all of our free margin when an open position runs away against us, resulting in a margin call.
Let’s now say that the trades we opened in the example above have gone against us and are deep into the red. If our equity falls below our used margin, then our margin level dips below 100% and our account can no longer cover our margin requirements for the position.
This is when our Forex broker will usually request that we top up our equity in order to keep positions open by issuing what’s known as a margin call. If we fail to do so and our positions continue to decline, our broker will be forced to liquidate our open positions for us.
Forex Margin Calls and Tips to Avoid Them
If you’re a new Forex trader who’s been Forex margin called, no doubt you were left feeling confused and angry at your broker. You’ve now reached a crossroads where you either give up trading, or you take the necessary steps required to stop it from happening again. Familiarise yourself with what is a pip in Forex to help calculate risk and reward.
- Reduce your leverage: Even if your broker offers you leverage of 1000:1, you don’t have to use it. By reducing your leverage, you are leaving more free margin available in your account.
- Leave more free margin: Free margin can be left, simply by trading smaller lot sizes. It’s widely accepted that you should never risk more than 2% of your account equity on any single trade.
- Manage your risk: The easiest way to manage your risk is to plan your trades, use stop losses and adjust your position sizing accordingly. Keep your risk at a consistent 2% of equity and you’ll never receive a margin call from a single bad trade.
- Never revenge trade: There’s no feeling quite like having your positions forcibly liquidated after a margin call. But you must never let your emotions get the better of you by trading outside your plan, no matter how bad you want that feeling to go away.
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Final Thoughts on What is Margin in Forex
Never forget that trading on margin in the world of Forex can truly be a double-edged sword. This means that while your profits can be magnified, so can your losses at an equal level.
Choosing to trade Forex on a margin account is a responsibility that mustn’t ever be taken lightly. You’re trading with your broker’s money whenever you open a position and you must always ensure you’re playing by their rules, keeping your margin level well above 100% and following prudent risk management principles.
Being margin called by your broker is an experience we wouldn’t wish on anyone and hopefully, by learning the basics of what is margin in Forex, you’ll never have to experience it for yourself. Ready to start trading? Read this beginner guide on how to start Forex trading.
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