Everything You Need to Know About Margin Levels in Forex Trading
What Does Margin Mean?
Margin is a concept used across all financial markets but is particularly important in forex trading.
So what is ‘margin’ in forex? Effectively margin is a deposit that you need to put down to buy or sell a particular financial product.
The most obvious example is the CFD (Contract for Difference). Let’s say you want to purchase a single product with a value of $1000. Depending on your broker, they will require you have this deposit amount, sitting in your account.
The amount of margin required could vary from 1% to 100%. Margin requirements are generally set by your forex broker and will at times, take into consideration both your experience and certain jurisdictional and legal requirements.
So you could be required to only have $10 in your account to control a $1000 investment. While on the surface this is an advantage, it, of course, comes with risks.
The higher the margin that you are using them magnificent your position is. What you are doing by using margin is to effectively leverage your position. And when you leverage a position, you will gain more, relative to the moves in the product.
Margin will effectively magnify both your gains and your losses.
We can look at an example to show how this works in practice.
If we have a $1000 investment we only need to put down a percentage of that.
If we have 1:1 margin (no leverage at all):
We outlay the full $1000 and a 5% move in either direction will lead to a gain or loss of $50.
So in this example, we are effectively making or losing 5% on our outlay ($1000).
If we have 10:1 margin:
We outlay only $100 but a 5% move in either direction will lead to a gain or loss of $50.
So in this example, we are effectively making or losing 50% on our outlay ($100), which as we know is significant.
If we have 100:1 margin:
We outlay only $10 but a 5% move in either direction will lead to a gain or loss of $50.
So in this example, we are effectively making or losing 500% on our outlay ($100), which as we know is enough to put our account at risk.
Given that small changes in prices in the underlying product are magnified, is why margin needs to be used responsibly and it is always advisable to use less margin to not put your trading account at risk.
How to Calculate Margin Levels?
Margin level is the total sum of margin ‘deposits’ that you are required to make at any one moment in time.
For example, if you have multiple positions on at the same time, each of those will require you put up various amounts of margin.
The sum total of those individual margin requirements is what is known as the margin level.
Margin level = (equity/used margin) x 100.
When your margin level is greater than the value of your account, your broker will not allow you to put on any more positions.
It is also worth noting that margin levels are impacted not just be the initial margin (or deposit) amount that is required, but also by the unrealized profit or loss from the individual trades and the sum of all the trades.
This means that your margin level is a dynamic number and will vary throughout the day.
Ideally, when you’re trading, you should ensure that you have adequate room in your trading account to be able to put on new positions and that you are not using too much of your account equity on any one position.
Margin Levels and a Margin Call
A margin call in forex occurs when a position moves against you to the point that your account has not got enough equity remaining to cover the margin of the original position.
In that instance, you will experience a margin call from your broker. What will likely happen is they will either immediately close out your open position, or they will require you to add more equity to your trading account.
Here’s an example:
Let’s say you have a $10,000 trading account. You open a position that requires you to have $2,000 in your account.
That means your margin level is $10,000 – $2,000 = $8,000
If that trade goes against you and it drops by greater than that margin level, then you will experience a margin call.
In this example, the trade would need to lose $8,000 to drop under the required margin amount, which is $2,000.
As you can see, it is important to closely monitor both your open positions, your current profit and loss on each position, your margin requirements and the total account equity you currently have.
What is a Free Margin in Forex?
Free margin in forex is the amount of available margin you have in which to put on positions.
Free margin is the difference between your account equity value and the required margin of your current open positions.
Free Margin = Account Equity – Margin of Open Positions
If you are looking to open a new position and there is not sufficient free equity in your trading account, then your broker won’t allow that position to be opened.
Free margin is also impacted by changes in profit and loss on your current positions, so again it is important to keep monitoring the status of both your account equity, current positions and free margin, prior to entering any trades.
If you don’t have enough free margin, or if it is very close, there is a high chance that you’ll be subject to a margin call from your broker if your trade goes against you.
That can often be a source of frustration for traders as they might be in what they consider to be a good trade, only for it to be closed out on them by their broker, due to insufficient free margin in their trading accounts.
Forex Margin Summary
Margin in forex is a very important concept that is often missed by newer traders. Quite often it is not bad trading ideas, but poor management of capital and margin requirements that lead traders to lose money and blow up trading accounts.
However, it is relatively simple to monitor your account and keep a clear understanding of how to best manage a position based on its required margin.
It is also important to note, that you don’t need to trade with the maximum available margin on any product.
Just because you are able to access a 100:1 margin doesn’t mean that you should. At FX Leaders we often advise traders to never use more than 10:1 and to always keep a close eye on your free margin, prior to putting on any live positions. Ideally, you should probably be using even less, so under 5:1 margin.
It’s even more important to consider margin levels when trading in volatile markets, or in forex pairs that feature a currency that could be pegged and would be subject to large moves.