“Trading on margin” is another way of saying that you are borrowing money from your broker. This gets done to increase your market's exposure. The money will get borrowed by your broker, and the leverage ratio that gets used will determine the amount, with the collateral being a fraction of your trading account. This gets referred to as margin for that trade.
What is Free Margin?
Free margin will act as the amount remaining in your account. These funds are required to survive the possible adverse fluctuations from your leverage positions or, if you want, to open new leverage trades.
Calculating Free Margin
Free margin is the total of your trade balance that's available for the opening up of new spot positions on margin.
When calculating free margin, we use the formula equity minus used margin.
Let's use an example where equity is $6,250, and the used margin is $4,250. Free margin gets calculated as
$6,250 – $4,250 = $2,000
Equity can get defined as the total account balance and the unrealized gains and losses from open positions. The total cash deposited in your trading account is the account balance. Your equity is equal to your trading account balance if there are no open trades.
Let's calculate equity before we get started:
It's easy to calculate equity when there aren't any open positions.
Equity = account balance + floating profits (or losses)
$2,000 = $2,000 + $0
Therefore, your equity is the same as your balance. There aren't any open positions due to there being no floating profits or losses.
You have a trading account balance of $2,000 and a margin of 10%. You would like to open a position that costs $4,000. Opening the trade would look something like this:
- Account balance = $ 2,000
- Margin = $ 400 (10% of $4,000)
- Equity = $1,600
- Free Margin = $1,800 (Equity-Used Margin)
Let’s pretend that your position’s value increases, and there’s an unrealized profit of $20. We can then determine as follows:
- Account Balance = $2,000
- Margin = $400
- Equity = $1,620
- Free Margin = $1,820
There is no change with the account balance and used margin, whereas the equity and free margin increased to demonstrate the open position's unrealized profit. If there was a decrease in the position's value by $20, then the equity and free margin will decrease by $20.
What is FX Margin Level?
The Forex Margin Level is a percentage demonstrating the proportion between used margin and equity. You can calculate it as follows:
Margin Level = (Equity / Used Margin) * 100
Brokers use margin levels to determine if Forex traders can or cannot take new positions. If the margin level is 0%, it suggests no open positions in the open account. If the margin level is 100%, the used margin equals the account equity. Your broker will then anticipate you to add additional funds to your account if you wish to make more trades. More trades can get added if your unrealized profits increase.
Calculating the Margin Level
You can calculate the margin level as follows:
Margin level = (Equity / Used Margin) x 100 %
Your margin level should automatically get calculated on the platform you use to trade. If there are no open trades, your margin level will be 0. Several brokers will set the limit at 100%, meaning the equity is less than or equivalent to the used margin, and you can't open any new positions. You will need to close some options first before you intend on opening any new margins.
If your equity is $5,000 and the used margin is $1,000, your margin level is 500%.
What is FX Margin Call?
A margin call is when you have received a notification from your broker that your margin level has dropped lower than a certain threshold. We refer to the threshold as the margin call level.
Brokers differ with the margin call level, but they still happen before needing to resort to a stop-out. You receive a warning that the market is moving against you, and you have to act accordingly. You get warned by brokers to avoid situations where the trader cannot afford to have their losses covered.
It's important to consider that if the market moves fast against you, your broker may not be able to make the margin call before reaching the stop level.
Through checking your account balance, the margin call can get avoided. You can similarly utilize stop-loss orders on each of your created positions. A risk management plan should get applied within your trading ventures. You can be more equipped to expect and avoid them when your risk gets managed.
Traders might claim having too much margin can be dangerous. Though, your experience and style of trading will get depended on. If you have a high margin level – the higher your free margin will be for you to trade. So long as you have an understanding of the risks involved, trading on margin can be a profitable forex strategy.
It's essential to know the operation of your account if you decide to utilize the forex margin. To guarantee you have clarification, if you misunderstand something, read through the margin agreement that's in place between yourself and your broker.