When you start trading forex, you will come across several terms. Among these terms is the margin. It’s a common term used in Contracts for Difference (CFDs) and forex. However, if it is a new concept for you, you will learn everything about forex margin trading.
Understandably, for new traders, margin trading can be easily misunderstood. Margin in forex trading represents the least amount you need to open a leveraged trade. Nowadays, experienced traders use margin as a risk management tool.
The idea of margin is closely associated with a margin call, which buyers or traders do everything possible to avoid. Having a misconception about margin can be a costly mistake, which is why forex traders must have solid information about margin before starting trading.
What is a margin in forex trading?
Margin in the forex market is the collateral traders need to deposit to open a trade. Normally, it is the minimum or least amount a trader requires to open a position in their trading account. It is usually expressed as a fraction of a trading position while represented as a percentage. Another way to see margin is the initial deposit required for all open positions or forex trade.
Each forex broker needs a particularly required margin to determine the maximum leverage limits trader can use. Trading on leverage or leveraged forex trading is also known as trading on margin, and it has different consequences. Furthermore, leverage can influence trading outcomes either negatively or positively. It means trading margin can potentially increase your profits or losses once things go with/against your plan.
Forex Margin Requirements
A forex broker sets the margin needs, and it is based on the risk level they are ready to take. Additionally, while offering margin requirements, they adhere to regulatory restrictions and authority. In trading using forex margin, it is essential to remember the amount of margin you need to open a position; your trade size will determine the margin you use. During a period of high volatility, margin requirements can be increased temporarily.
Once you understand margin needs, you require to ensure the trading account value has sufficient funds to avoid a margin call. An easier way to track your account status is through a forex margin level. To calculate your forex margin level, you need to divide your equity by the margin used before multiplying the outcome by 100.
Margin Level = (Equity/margin used) x 100
Assuming a trader deposit $10,000 and use $8000 as margin. The margin level would be equivalent to 125 and directly above the 100 level. However, if the forex margin level goes below 100, your broker will stop you from opening new or further trades and place your account on a margin call. As the account equity will dip below the needed numbers.
What is Margin Call?
The biggest nightmare of any professional forex trader is receiving a margin call from their broker. A margin stop call is a notification you receive, indicating your account equity is below the margin required level.
Each broker calculates their margin level differently and warns traders that the market moves against their position. Furthermore, it allows traders to act or decide whether to close their position or not. Brokers use margin calls to help traders mitigate their losses.
Do Forex Brokers profit using Margin?
There is a common fallacy among those trading foreign exchange about brokers profiting from the margin. Margin carriers have no transaction cost, and forex brokers don’t benefit when offering margin to traders.
However, what margin does is ensure a trader’s account has a certain amount set aside to cover any losses they might incur in their opened position. Looking at a margin on a deeper level, although the broker might not profit directly from the margin, traders indirectly benefit from it.
Risk Management in Margin Trading
When trading the foreign currency market using a margined account, forex traders need to know how to calculate the margin required for each position if it isn’t available on your deal ticket automatically. Nevertheless, you must understand the difference between leverage and margin.
To avoid the high risk of losing your funds, you need to monitor important news released using an economic calendar. An economic calendar will help you avoid possible losses during a volatile period and protect you from high market exposure.
Notably, including risk management as part of the trading style can help avoiding the risks involved in margin trade. Furthermore, ensure you have sufficient funds in your equity as a free margin since the higher free margin, the more room to execute the trades. It could help you prevent margin closes from your broker.
Relationship between Margin Required and Leverage
The lower margin requirement may look attractive since it allows you to open the same position using a fewer dollar. Nevertheless, you need to be careful to be a profitable trader, else if you have a bad trade, your losses may become amplified due to leveraged trading.
Lower margins lead to higher inherent risk as margin carries significant risk. When you fail to consider the implication of a lower margin, you stand to suffer significant possible losses. Nevertheless, high leverage means you won’t get margin calls quickly. But you will experience significant possible losses when using higher leverage. Higher leverage also minimizes your profit potential, discouraging some traders who consider the risk and reward not worth using through a margin order.
Forex Margin Calculator
It can be a daunting task for new traders trying to calculate forex margin to use when trade foreign exchange. However, the margin calculator makes it easy to calculate the margin they require to maintain their trading account. Furthermore, it helps traders manage their trades and determine the leverage level and position size they shouldn’t exceed.
The margin calculator helps you to avoid stop-outs that lead to closing your positions. It usually follows three steps to calculate the margin requirements. To begin, you have to choose your account currency (dollars, Pounds, euros, etc.) and set the currency pair you want to trade. Once you are done with account currency selection, you set the position size you want, and the forex margin calculator will automatically display your margin for that particular trade.
Potential Advantages Of Margin Trading
Here are a few potential advantages of using margin to trade forex.
- Increased buying power: It’s one of the obvious benefits of margin trading because it allows traders to control larger forex positions using small capital. You can borrow funds from your broker to open a bigger position that your capital might not accommodate.
- Flexibility: Margin trading gives you flexibility in building a portfolio of your choice to full value. For instance, your small account can only take one position at a time. However, with margin, you can use your equity to open multiple trades, thereby diversifying your initial investment to full value.
Potential Disadvantages of Margin Trading
While margin trading is enticing for traders to take advantage of, it has certain limitations that can affect traders who don’t use it properly. Let’s look at a few disadvantages of margin trading.
- High risk: The ability to control larger positions also come with the possible high risk of losing.
- Stress: A few traders find it hard to deal with the stress of opening large positions because of market fluctuations in their unrealized profit or losses. As a result, they make irrational decisions that might affect their account. Significantly, not allowing your emotion to get the better end of you can help save you in the long term.
- Margin calls: It’s one notification no trader wants to see. Receiving a margin call means you have low equity to handle or support your current trade. Margin trading exposes you to margin calls from brokers if you have a terrible money management plan.
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Forex Margin Terminology
- Margin Level: The deposit margin you need to place a leveraged trade
- Equity: Represents the trading account balance after adding your current gains and subtracting your current losses from your account balance
- Free Margin: The free margin is the equity in your trading account after deducting the margin you used.
- Used Margin: A part of your equity set aside to maintain existing forex trades is the used margin.
Frequently Asked Questions
What is a margin in forex trading?
Margin in forex trading is the amount of money you need as a “good faith deposit” to open a trade with a broker. It is usually expressed in terms of percentage.
How is margin calculated in forex?
To understand how to calculate margin in fx, we will use an example to make it easier. Assuming a broker offers a leverage of 1:50 when trading forex, it means for every 50 units of currency in an open position, a unit of the currency is needed as the margin. Therefore, if the size for your position was $50, your margin would be $1. Therefore, your margin deposit would be 1/50. Alternatively, your margin percentage will be 2%.
What is a good margin level in forex?
When you open a position, your broker will hold that initial margin or deposit as collateral. The used margin is the total amount your broker keeps to maintain the position. However, there is no one size fit when using margin in forex. It is advisable to ensure that your margin level is above 100%.
What does a 5% margin mean?
Understanding how margin calculations take place is very important. A 5% margin means that the leverage your broker is offering you is 1:20. The margin percentage is directly related to the leverage a broker offers. The margin carries a significant risk that needs to be looked at.
Conclusion
Forex margin trading isn’t a new theory for most traders. Although some traders argue it is very dangerous, some have included it in their trading style. Margin trading can be a profitable approach in the forex markets if you understand it but risk must be considered for clear investment objectives. It can be done after one seeks independent advice.
However, it is associated with a high risk of losing. It can increase your purchasing power and also lead to magnified losses, especially if the market doesn’t go in the direction you expect. Therefore, it is crucial to be extremely careful when using margin.
The information above is for education purposes only and cannot be considered as investment research or advice. Past performance is not a reliable indicator of future results.
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