What Is Margin In Forex Trading? Forex Margin Explained

Introduction

A massive reason why the FX market is so popular and accessible is how much leverage traders have. Even with a relatively small balance, you can supercharge your gains, assuming, of course, that you have the right skill. 

The whole concept of Forex margin is to trade bigger with less money in your account. It is like a loan your broker gives you to increase your profits substantially. Needless to say, it can also wipe out your balance if not used properly. 

Still, understanding margin is essential to money management and your ultimate success as a trader. Without further ado, let’s dive into this topic in much more detail.

What does margin mean in Forex?

Margin refers to the funds needed to open a leveraged position. Forex margin trading and leverage go hand in hand, even if the two are slightly different. Essentially, leverage creates margin.

Leverage refers to amplified trading power, a collateral mechanism in your account allowing you to trade far bigger positions with a relatively lower balance. Naturally, the units of currency pairs are expensive to trade for many people.

With Forex margin, you only need to have enough funds to meet and maintain the margin requirement for each position. Due to this feature, your trading account balance never represents all your risk capital.

Below is an image of the different trade sizes and the minimum account balances you need to open each based on required Forex margin.

Let’s assume you wanted to trade a standard lot on EUR/USD, worth $100 000 or 100 000 units. Without FX margin, you would actually need to put up the entire $100 000 upfront. 

However, with margin, your broker only needs a ‘good faith’ deposit, a much smaller amount than the normal value of the pair. A Forex margin requirement of 2% in this scenario equals 1:50 leverage. How did we get this figure?

1 / Forex margin requirement X 100

{1 / 2} X 100 = 50

For this example, you only need $2000 (2% of $100 000) to control a position worth $100 000, with the broker providing the remainder.

As long as your balance doesn’t fall below $2000, you can maintain this position. Now here comes the tricky part, and here’s why they say ‘leverage is a double-edged sword.’ You may notice that controlling $100 000 with only $2000 is massive leverage.

If the exchange rate moves against this position, the chance of blowing your account increases much faster than someone with a higher balance. At the same time, if the pair travelled in your favour, your $2000 would quickly change into a greater amount.

Let’s go back to the worst scenario. If you meet the minimum Forex margin requirement, your broker sets a margin call level (more on this later). This is simply a point where your account is at risk of liquidation with mounting running losses.

So, when you reach a Forex trading margin call, your charting software usually notifies you with a visual alert. If you wished to maintain the position, you would need to deposit more money.

Otherwise, if the exchange kept moving unfavorably, the software would automatically close out your positions at some point to prevent your balance from going below zero. Nowadays, most brokers have negative balance protection for this reason.

Forex is, by far, the most leveraged financial instrument globally. Brokers offer incredibly low Forex margin requirements, sometimes as much as 0.1% or lower in some cases. Below is a table of common percentages and their respective leverage ratios.

Each pair in the FX market carries a different weight, with some being more expensive or cheaper than others. Therefore, the Forex margin requirements vary widely, depending on the size of your position (also covered later).

The point is you need to account for each position individually when it comes to exposure to practice good money management. Fortunately, while we will cover the math behind the calculations, plenty of free margin calculators online do the job.

Before we go into calculating Forex margin, here are some terms to familiarize yourself with to help you grasp this topic.

• Balance: the amount of money presently in your account
• Equity: your balance accounting for all running profits and losses
• Used margin: the total amount of margin used to open all positions
• Free margin: the remaining margin left which you can use to open new trades
• Margin level: a percentage of available margin

The image below is a trading terminal on MetaTrader 4. We will use this example to illustrate the terms above.

Balance

For FX margin, the balance is simply the funds you have deposited in your account. Your balance will always remain fixed unless one of three things happens:

• You add more money
• You transfer some or all of the funds
• A position is closed for a profit (greater balance) or loss (lower balance)

When you add more funds to your balance, this understandably offers higher Forex margin. Generally, many traders tend to withdraw once all their positions have been closed. Yet, nothing is stopping you from withdrawing even when they aren’t.

Also, with some brokers, you are not withdrawing but transferring the funds from the terminal to a designated wallet. Here, you can decide to initiate a formal withdrawal to your bank account or re-transfer the funds to your trading software.

In the image above, the balance is $45.89. Here, the trader could decide to take out this entire amount, effectively leaving their account at zero. However, their positions would still remain because their free margin ($685.84) is greater than the initial margin of their positions ($52.32).

Equity

For margin Forex trading, your equity represents all your floating unrealized profits and losses.  Equity also considers transaction costs (where the broker is not charging a spread) and swaps.

Think of it as your real-time balance. It’s a figure that shows what your account would look like if you closed all positions at once. 

Unlike your balance, which always remains fixed (unless you add money or close your orders), your equity fluctuates every second. This fluctuation depends on your running losses and profits.

Of course, if your equity is higher than your balance, that’s a good sign; the opposite is true. One key thing to note is you should never mistake your equity for cash in the bank. Some traders may instinctively close their positions if their running profits seem impressive.

Generally, you plan how long you aim to hold a position until it reaches the desired target. We use trailing stops to secure a portion of the profits at a certain level. We would have realized gains if the market reached this point (assuming no slippage) or we manually closed our orders.

Used margin

This is represented as ‘Margin’ on the MetaTrader 4 and MetaTrader 5 platforms.” However, it is the aggregate Forex margin used for all your positions. In the next section, we’ll explore more about the calculations.

For now, remember the most crucial point here. You never want your equity to fall below your used margin, as it would suggest one or a few large unrealised losses.

Free margin

This metric is essentially:

Equity – Used Margin

As you see in the same image again below, $738.16 (equity) subtracted from the used margin ($52.32) equals $685.84 (free margin).

Free margin is the Forex margin available for utilisation with running trades. Like equity, it fluctuates with your floating P&L. Even with a smaller balance, you can use all of the free margin to open larger-sized positions. 

However, this may be dangerous in many cases. Therefore, you may need to close some of your trades or deposit more money. We can also think of free margin as the ‘buffer’ you have that trades can move against you before a margin call or stop-out.

Margin level

The Forex margin level is simply a percentage representation of your free margin, a different way of interpreting it. Your trading software automatically calculates it as prices fluctuate, but here is the formula:

Margin Level = (Equity / Used Margin) x 100%

In the image above:

1410.93% = (738.16 / 52.32) X 100

How is Forex margin calculated?

The first step to calculating Forex margin is to know how much leverage you have from your broker. You can change your leverage up to a set number of times (but never beyond the maximum available on each instance).

The formula is:

Margin = Trade size X current conversion price / leverage ratio

The trade size is represented in units, while the conversion price is the base currency exchange rate related to the pair in question. For instance, if your account currency is USD and you were trading NZD/JPY, the conversion price would be based on NZD/USD.

We’ll go over three examples with different leverage ratios and pairs.

Example #1

If a broker offered maximum leverage of 1:500, and you wished to open a position with a 0.1 lot size on EUR/USD, the margin is $20.16:

(1.00804 X 10 000) / 500

Example #2

If a broker offered maximum leverage of 1:100, and you wished to open a position with 1 lot size on GBP/CHF, the margin is $1,162.74:

(100 000 X 1.16274) / 100

Example #3

If a broker offered maximum leverage of 1:200, and you wished to open a position with a 0.5 lot size on NZD/JPY, the margin is $146:

(50 000 X 0.584) / 200

The importance of position sizing

You can’t get a grip on margin trading Forex without understanding position sizing. It’s the most essential piece to the puzzle of money management. Margin, leverage, and position sizing all work in tandem.

The core is understanding the different notional quantities of currencies. For every position you execute in the markets, you are trading a particular number of contract units of the base currency (the currency to the left of a pair). 

For instance, when trading EUR/USD, you are trading a certain amount of euro against the US dollar. We express positions in Forex according to lot sizes:

• A standard lot size is 100 000 units of the base currency (1 lot)
• A mini lot size is 10 000 units of the base currency (0.1 lots )
• A micro lot size is 1 000 units of the base currency (0.01 lots)
• A nano lot size is 100 units of the base currency (0.001 lots)

Each minimum lot goes up in increments of 1. So, for instance, 0.002 nano lot is 200 units; 0.02 micro lots is 2000 units; 0.2 mini lots is 20 000 units, and so on for each figure.

Before executing any position, you should always use a margin calculator to know the appropriate number of lots to trade. This is a common mistake committed by even the most experienced traders.

Forex is naturally a highly leveraged market. This means that, without being cautious, you can erroneously open a much bigger position than what your account would allow under normal circumstances.

Needless to say, this is the fastest way to get your account nearing a margin call. Another rookie mistake is using the same lot size across multiple pairs. 0.1 lots on the euro doesn’t carry the same weight as on a more volatile pair like GBP/CAD.

So, it’s vital to understand that each market has its own Forex margin requirement. The purpose of a calculator is to implement a lot size in line with a comfortable monetary threshold based on how much you plan to risk per position.

Using a calculator only takes a minute, but it’s necessary and prevents you from losing a large sum unnecessarily.

What is a margin call?

Margin in Forex trading is a bit like a car. Everyone knows the maximum speed limit, but it wouldn’t be smart to drive it to that peak. Similarly, there is no need to utilise all of your available Forex trading margin when trading.

However, once you exceed a certain point, it spells danger. While leverage is a double-edged sword, you can decide how deep it cuts. Using too much leverage quickly nears your account to the point of no return.

A margin call refers to a threshold when the margin level is below a defined percentage due to mounting unrealised losses. Here, you cannot open new positions without closing them or depositing more funds.

Should neither of these happen, you risk having your orders automatically liquidated by your trading platform. It’s a sign that your equity is too small to handle your losses. Therefore, closing them is the only way to prevent the trader from potentially owing the broker due to a negative balance.

In the old days, your broker would warn you via the phone once your account was in a margin call. However, nowadays, we use notifications. If you’re familiar with the MetaTrader platforms, you’ll know the bottom of your trading terminal will show red. 

A margin call is more like an orange traffic light (although you don’t want to be anywhere near this point). On the other hand, the stop-out level is the red light. 

The automatic liquidation technically occurs once your margin level falls to this percentage. Sadly, you cannot stop this process when it starts happening.

If you have multiple losing positions, the broker will close the largest ones, working their way down. Generally, the Forex trading margin call percentage is 100%, while the stop-out level is 50%, as in the image below.

However, these figures are the average. Some brokers have tighter or narrower forex margin call/stop-out levels. So, you need to verify with them beforehand. 

Regardless, a margin call is not a place any trader wants to be. Fortunately, this is not something you should worry about once you become more risk-averse. Here are the most common reasons it happens:

• Holding onto a losing position for a very long time (usually without a stop loss)
• Incorrect position sizing resulting in losses accumulating quickly
• Having an under-funded account

How to prevent a forex trading margin call

Fortunately, it’s not rocket science. Here are the key things to keep in mind.

Conservative risk

Experts generally recommend not exceeding 2% of your equity for every position. Conservative risk means you can absorb a string of losses and still have a decent chunk of your account.

If you increased this figure to, let’s say, 20%, it would take four consecutive losses to lose 80% of your account. On the fifth trade, you would have far less margin than previously. 

What often happens with losing traders is they use the same lot sizes even when their equity has decreased by a lot. Needless to say, this amplifies your chances of blowing your account.

Always use a position size calculator

Even if you risk small, you should align this with the appropriate number of contracts. Your position size must represent the fixed percentage of your equity in dollar terms.

Use a stop loss for each position

No one knows how long a trade can go against them. It could be 10, 100, or 1000 pips. Fortunately, you don’t have to guess once you define a limit. Using a stop loss is a no-brainer when considering the consequences of Forex trading margin.

Many traders who blow their account use too much margin on one or a few positions without applying stops.

Beware of ‘scaling in’

‘Scaling in’ is when you incrementally add extra positions to your original order to increase your profit potential. This is an advanced technique that many traders, particularly scalpers, haven’t mastered with proper money management.

Often, they scale in very close to the price of their original positions. Ideally, you’ll want your first order to have some profit that you can secure with a stop loss.

However, if scaling in is done illogically, it is a form of over-leveraging because you are using twice or more of your FX margin. This drastically increases the chances of depleting your account if the price moves unfavorably to your positions.

The point is not to avoid scaling. However, you need to perform this technique with the strongest consideration of risk.

Conclusion

Once you have solid risk and money management skills, leverage can offer you impressive returns. Without it, traders would need to invest substantially more capital. 

While this mechanism is wonderful, leverage can amplify your losses if not used appropriately. 

Fortunately, with Galileo FX, there is no need to worry about forex margin calculations. Check it out if you’re looking for the best trading robot.