The real beauty of Forex trading is in the range of possibilities. Practically anyone can become a profitable trader, after finding the right approach and paying attention to details. Today we discuss one of the trading concepts that help currency traders everywhere enhance their experience and optimize the gain. Simply: what is margin in Forex and how you can benefit from using it in 2020.
What is Margin on Forex
A margin in Forex is a security tool that brokers need to cover a portion of their risk. When a trader opens a new position, a small portion of their account balance is held aside as collateral. This way, in case the things don’t go according to plan, margin protects both the broker and the trader. So, the easiest way to answer what is margin in Forex is a deposit on each new trade, required to open a position.
Each broker has their own Forex margins conditions. Upon making an agreement with the brokerage services provider, make sure you understand the concept of margin as well as the specific conditions suggested by the broker.
The size of the margin directly reflects in the amount of leverage your broker will be able to provide. Sometimes, trading on leverage is referred to as trading on margin, however, it isn’t entirely the same thing. Leverage is an account balance magnifying tool, that helps traders operate with larger amounts of money. While Forex margins are a form of safety deposit that applies to all types of trades, whether or not leverage is used.
Trading on leverage is an advanced approach to currency exchange, therefore it makes sense to get a full understanding of how margins in Forex work and what is the best way to trade on margin.
Example of Calculating Forex Margins
For instance, your broker offers a leverage rate of 1:50. This means that for every 50 currency units in your new position, 1 unit will be taken as margin on Forex. Translated into money this means setting aside $1 for margin for every $50 traded. In this case, the margin is 2%.
To see the same logic in reverse, let’s assume that your broker requires a 5% margin. This way, for every $100 you trade, $5 will be held aside as margin, making your leverage ratio 1:20.
Fortunately, you don’t have to dive into math each time you need to translate margin in Forex and leverage ratios into money values. For that, there are Forex margins calculators.
Forex Margin Calculator
Many brokers will simplify your trading-related calculations by providing a set of tools. One of such tools is the calculator for margin in Forex. This interactive instrument will be able to tell you how much of your account balance will be taken as margin, as well as help you predict the possible losses and gains associated with the chosen leverage.
The calculation of what is margin in Forex is always specific to each trader’s strategy, leverage amount, and even the account type. So, make sure to correctly input the proper data in order to get the most accurate results.
What is a Free Margin on Forex
At this point, you know what is margin in Forex and how it can be calculated. Now, let’s take a look at the concept of free margin. In this case, ‘free’ means available and it indicates the amount of money the trader has accessible for opening new positions. You can determine the free margin by subtracting the used margin from the account’s equity.
Account equity is the combination of all the assets in the account. If there aren’t any open trades equity simply equals the account balance. However, if there is at least one position open, the equity will count in the unrealized gains and losses including the Forex margins used in the process.
Since the already open trades also contribute to equity, you have an option to use the prodigy from those ongoing positions to cover the margin for any additional one. Below is an example of how this will work.
Example of Free Margin in Forex
For instance, your trading account balance is $5,000, and your broker requires a margin of 10%. You are looking to open a position that costs $10,000. As you open the trade, the following breakdown will form: account balance is $5,000, the margin is $1,000 (10% of $10,000), free margin is $4,000 and equity is $5,000.
In the scenario, when the position’s value grows and gives you an unrealized profit of $100, the free margin and equity will also increase by $100, becoming $4,100 and $5,100 respectively.
And if the position decreases in value by $100, the opposite will apply: free margin will go down to $3,900 and the equity will become $4,900. Note, that the account balance and the margin cost don’t change until the profit or loss is realized.
The relationship between equity and the used margin is expressed in the concept of the Forex margin level. So, next, we explore what is margin level in Forex and why is it important to keep an eye on it all throughout your trading.
What is Margin Level in Forex
The margin level in Forex is a percentage that reflects the ratio of used margin to equity. The formula for margin level is equity divided by a used margin and multiplied by a hundred. This result will show the broker and the trader how many trading possibilities the account has. A 100% means there are no funds available for trading, and 0% means there are no positions currently open.
For a trader, watching the margin level in Forex is vital. The closer that percentage is to a hundred, the closer is the necessity of a new deposit. Depending on the transferring channel you use for depositing and withdrawing from your Forex account, it can take a certain amount of time before the money reaches the destination. That’s why it is smart to start planning your deposits and withdrawals in advance to make sure every trading opportunity is seized. Let’s look at the example of what is margin level in Forex in action.
Forex Margin Level Example
Let’s use the account balance of $5,000 with a 10% margin from the previous example. If you’d like to open a position worth your entire balance, the margin will equal $500. In theory, if the market starts moving against you, you can reach as much as $4,500 in losses. However, depending on the broker the losses might be cut short sooner.
Every broker has their own vision of Forex what is margin level, meaning that they will establish different maximum level values for the trades to be automatically executed. This maximum value is referred to as stop out level and it simply indicates the line on the Forex margin level scale at which all losing trades will be closed.
The losing positions are closed in the descending order, from the biggest one to the smallest one. As the execution proceeds, used Forex margins get released and the margin level might sometimes balance out far away from the stop out.
There are three possible scenarios when the margin level is approaching the stop out. One is to sit idle and see if the things turn around in your favor, in volatile markets the margin level can fluctuate almost as dramatically as the price itself. Another solution is to execute the losing trade yourself, without waiting for it to reach the stop out. And the third way to approach this situation is to top up the account balance, in turn increasing the free margin and reducing the margin level.
Forex Margin Call
The margin call is a signal that the price moving against you is reaching into a critical area. Just as brokers have different stop out levels, they will also have different margin call set-ups. Although a lot of traders think of margin calls as something scary, they can actually be quite helpful.
In the chaotic conditions of a fast-moving market, it can be challenging to remain in control over anything. Especially with several positions open simultaneously, traders often overlook the margin level Forex and only get to notice it when it’s too late. By letting you know that things are about to go south, brokers give you a sufficient amount of time to take appropriate measures, described above, at the same time making sure they won’t bear too many losses supporting your position.
Watching the margin level in Forex isn’t the only solution to avoiding margin calls. A trader has to implement several risk managing techniques to go along with their strategy. This way, even if the situation appears to be unpleasant, the account balance will not be harmed too badly. Keep in mind that there are times when the market is moving forward too fast and a broker simply doesn’t have time to execute a margin call. That’s when comprehensive risk management is absolutely necessary.
One of the ways to cut your losses before it’s too late is by mastering the use of automated orders, such as stop loss. By placing stop-loss orders within a reasonable distance from the price movement, for instance at the support level in case of a long position, a trader can make sure that the loss will be easier to handle. Of course, it is impossible to avoid every possible risk during Forex trading, but being aware of the risks and optimizing your trading process accordingly is always beneficial.
So, far you might think that the margin level in Forex, as well as margins themselves, are not too complex. And it’s partially true. Everything in Forex trading can be broken down into simple to comprehend parts. However, in order to get an even deeper understanding of margin in Forex, it won’t hurt to experiment with trading on margin in the simulation environment.
Practice Trading on Forex Margins in Demo
A demo account for Forex trading can be an incredible tool for getting to know an unfamiliar tool, strategy, or concept. Demo accounts are precise copies of the live trading accounts, only the trading process is fully simulated. With that said, your demo account will still give you a pretty solid understanding of how each trade would play out if you were using the same setup in the live version.
Since the demo mode reflects the exact data from the actual market, the trading process will feel very real. But there is one significant advantage: there is no risk linked to trading in the demo because you don’t need to invest actual funds to use the simulator. That’s right, you have a perfect opportunity to practice for as long as you need to without risking a single penny.
The room for experimentation that traders get in the demo mode is not only a wonderful learning tool but also a pretty good confidence booster. As traders know there is nothing to lose, they feel free to make mistakes and learning from them. This invaluable experience of accepting failure and processing it for knowledge can become a great asset down the road when the real money is at stake.
And as for the trading on margin, the demo can give you a really good view of how trades play out when you use leverage. On the one hand you will see just how much more significant a profit earned with leverage can be, and on the other, you will learn to properly acknowledge and address the risks.
Forex Margins in 2020
2020 has given the way to hundreds of new traders around the world. The troubling instability of the first two quarters created an entire pool of opportunities. At the same time, the traders realized that they have to learn fast. A lot of vital concepts, like leverage and margin in Forex, got overlooked and led to upsetting results.
So, here are a few tips on how to wisely approach the margin level in Forex in 2020:
Get to know your broker’s rules and policies regarding the margin on Forex. This will include the available leverage ratios for the retail traders and for the professionals, the stop out conditions, the margin call rules, and so on.
Get enough practice and experience before trading on leverage. Without a doubt, leverage is an extremely helpful way to increase your profits, especially in short-term strategies like scalping. However, trading on margin calls for advanced levels of knowledge and attention to detail. That’s why it is better to get some tricks up your sleeve before considering leverage.
Make sure to diversify your trading portfolio by experimenting with various instruments. In case your broker allows several accounts with different base currencies, you can transfer funds between accounts to reduce the margin level and continue to trade. And even if you don’t want to transfer, you can just switch between the instruments to keep trading in comfortable conditions.
Master market analysis. The only traders who aren’t afraid of the margin call are the ones who know what will likely happen next. Of course, there is no way to completely forecast the upcoming price movement, but a thorough analysis can give you an idea of the general direction of the market and sometimes even the exact patterns.
Finally, make sure to take advantage of trading in the demo mode before you move onto the live trading account. The demo mode is ideal for all kinds of traders as is offers an unlimited amount of learning, practicing and experimenting opportunities.