Margin is one of the most important concepts of Forex trading. However, a lot of people don't understand its significance or simply misunderstand the term. Fortunately, we can help you out. What is known as a Forex margin is basically a good faith deposit that is needed to maintain open positions. A margin is not a fee or a transaction cost, but instead a portion of your account equity set aside and assigned as a margin deposit. We should warn you that trading on a margin can have different consequences. It can influence your trading experience both positively and negatively, with both profits and losses potentially being seriously augmented.
Your broker takes your margin deposit and then pools it with someone else's margin Forex deposits. Brokers do this in order to be able to place trades within the whole interbank network. A margin is often expressed as a percentage of the full amount of the chosen position. For instance, most Forex margin requirements are estimated to be: 2%, 1%, 0.5%, 0.25%. Based on the margin required by your FX broker, you can calculate the maximum leverage you can wield with the trading account you have.
In order to understand Forex trading better, one should know all they can about margins. We want you to get acquainted with the term Forex margin level, which you need to understand. The Forex margin level is the percentage value based on the amount of accessible usable margin versus used margin. In other words, it is the ratio of equity to margin, and is calculated in the following way: margin level = (equity/used margin) x 100. Brokers use margin levels in an attempt to detect whether FX traders can take any new positions or not.
Different brokers have different limits for the margin level, but most will set this limit as 100%. This limit is called margin call level. Technically, a 100% margin call level means that when your account margin level reaches 100%, you can still close your positions, but you cannot just take any new positions. As expected, 100% margin call levels occur when your account equity is equal to the margin. This usually happens when you have losing positions and the market is quickly and constantly going against you. When your account equity equals the margin, you will not be capable of taking any new positions.
What is margin level in Forex? We'll use an example to answer this question. Imagine that you have a $10,000 account and you have a losing position with a margin evaluated at $1,000. If your position goes against you and it goes to a $9,000 loss then the equity will be $1,000 (i.e $10,000 - $9,000), which equals the margin. Thus, the margin level will be 100%. Again, if the margin level reaches the rate of 100%, you can't take any new positions, unless the market suddenly turns around and your equity turns out to be greater than the margin.
Let us presume that the market keeps on going against you. In this case, the broker will simply have no choice but to shut down all your losing positions. This limit bears a special name and that is the stop out level. For example, when the stop out level is established at 5% by a broker, the platform will start closing your losing positions automatically if your margin level reaches 5%. It is important to note that it starts closing from the biggest losing position.
Often, closing one losing position will take the margin level Forex higher than 5% as it will release the margin of that position, so the total used margin will go lower and consequently the margin level will go higher. The system often takes the margin level higher than 5% by closing the biggest position first. If your other losing positions continue losing and the margin level reaches 5% once more, the system will just close another losing position.
You might ask why brokers even do this. Well, the reason why brokers close positions when the margin level reaches the stop out level is because they cannot permit traders to lose more money than they have deposited into their trading account. The market could potentially keep going against you forever and the broker cannot afford to pay for this sustained loss.
Free margin Forex is the amount of money that is not involved in any trade and you can use it to take more positions. That isn't all - the free margin is the difference of the equity and margin. If your open positions make you money, the more they go to profit then the greater equity you will have, so you will have more free margin.
There is one topic that ought to be discussed. There may be a situation when you have some open positions and also some pending orders simultaneously. The market wants to trigger one of your pending orders but you don't have enough Forex free margin in your account. That pending order will either not be triggered or will be cancelled automatically. This can cause some traders to think that their broker failed to carry out orders and that they are a bad broker. Of course in this instance, this just isn't true. It's simply because the trader didn't have enough free margin in their trading account.
We hope that we have answered the question - what is free margin in Forex?
A margin call is perhaps one of the biggest nightmares Forex traders can have. This happens when your broker informs you that your margin deposits have simply fallen below the required minimum level owing to the fact the open position has moved against you. Trading on margin can be a profitable Forex strategy, but it is important to understand all the possible risks. You should make sure you know how your margin account operates, and be sure to read the margin agreement between you and your selected broker. If there is anything you are unclear about in your agreement, ask questions.
There is one unpleasant fact for you to take into consideration about the margin call Forex. You might not even receive the margin call before your positions are liquidated. If the money in your account falls under the margin requirements, your broker will close some or all positions, as we have specified above several times. This can actually help prevent your account from falling into a negative balance.
How can you avoid this unanticipated surprise? Margin calls can be effectively avoided by carefully monitoring your account balance on a regular basis and by using stop-loss orders on every position to minimise the risk.
Margins are a debatable topic. Some traders argue that too much margin is very dangerous, however it all depends on the personality and the amount of trading experience one has. If you are going to trade on a margin account, it is important that you know what your broker's policies are on margin accounts and that you understand and are comfortable enough with the risks involved. Be careful to avoid a Forex margin call.
As we are approaching the end of our guide, it is important to draw your attention to one fact. Most brokers require a higher margin during the weekends. In fact, this might take the form of a 1% margin during the week and if you want to hold the position over the weekend, it may rise to 2% or higher.
As you understand, FX margins are one of the aspects of Forex trading that must not be overlooked as it could lead to an unpleasant outcome. In order to avoid it, you should understand the theory about margins, margin levels and margin calls, and apply your trading experience to create a viable Forex strategy. Indeed a well developed approach will undoubtedly give you profit in the end.