What is Margin in Forex – Forex Explained

What is margin in Forex, and how can you use it to increase your exposure to the market and your profits? Well, Forex margin trading can drastically change the way you think about Forex trading and the opportunities it offers. If you are unsure of what the concept of margin trading stands for, in this article, we will answer the questions: What is margin in Forex, what are its risks and advantages, and how to calculate the margin.

What is Margin Trading – What is Margin in Forex?

Foreign exchange margin represents a percentage of the total value of your trading position that you need to put forward to open a trade. Thus, margin trading allows Forex traders to increase the size of their trading position.

In a broader sense, this practice means using bowed funds for trading, be it currencies, indices, and so on.

For instance, imagine you want to buy a car that costs $10,000, but you only have $5,000. You can borrow the remaining $5,000 from a bank and use the car as collateral for the credit. However, if you fail to top up your debt, the bank will take your car to collect their money.

You can do the same in Forex, but instead of a bank loan, you get a loan from your broker. This is called leverage. Leverage gives traders an increased exposure to the financial market. But it requires a smaller initial investment, which is its main advantage.

However, beware that this practice is a double-edged sword since it can amplify both profits and potential loss. You need to have a clear picture of the total value of the trade you use leverage for, not just the amount needed to open the trade.

The Difference Between the Leverage and Margin

Leverage and margin trading in Forex are tightly related. As already mentioned, the margin is the amount you need to borrow from the Forex broker to open a position and keep the position active. Leverage hence refers to the Forex margin rate, which is the percentage of the whole trade value required to enter the trade.

For instance, let’s say you have a leverage of 30:1 available. It means you can enter the trade 30 times the initial investment. And if you dispose of, let’s say, $5,000, with the leverage of 30:1, you can control a trade of a total value of $150,000.

In the Forex market, the leverage is linked to the margin rate. The margin rate shows the trader what percentage of the full value is needed to enter the trade.

The currency price movements are measured in pips (percentage in points). And for majors such as GBP/USD, EUR/USD, a pip represents a movement of 0.0001.

So if the GBP/USD price moves from 1.4200 to 1.4300, we have a movement of 100 pips. It’s only one cent move that doesn’t seem like much, but the leverage used can bring a decent profit.

That’s why leverage plays a huge role in Forex trading, enabling the slightest price movements to be translated into significant profits.

Besides currency pairs trading, leverage is used in derivative product trading such as CFD trading of commodities, shares, and indices. CFDs are complex instruments and would require a whole other article to explain their purpose.

A Margin Trading Rate Example

If a broker offers you a margin rate of 3.3% and you aim to open a trade with $100,000, it means you have to deposit $3,300 to enter the Forex trade. The Forex broker would fund the remaining 96.7%.

Also, margin requirements depend on the type of your trading account. It won’t be the same for VIP accounts and beginner accounts.

Leverage available and margin requirement varies depending on the broker. In general, the leverage limits are imposed by the regulatory bodies. Therefore, the margin requirement depends on the location of your trading account. It usually starts at 3.3% for the major currencies.

What is the Margin Level in Forex?

In margin trading, you need to focus your attention on your margin level in order to know if you as a trader have means for opening new positions.

When you open a position, your initial deposit will be kept as collateral by the Forex broker. The full amount that the broker holds up to keep your positions open is called “used margin.”

The more positions you open, the more funds in your trading account become used margin. The amount you have left available to open further trading positions represents available equity, which can serve you to calculate the margin level.

The margin level stands for the ratio of equity (the amount on your trading account) to used margin, expressed in percentage. Here is the formula to calculate your margin level:

Margin level = (Equity / Used Margin) x 100

The minimum amount on your account (the equity) you must have to continue trading on margin is called maintenance margin. A minimum maintenance margin level imposed by most of the Forex brokers is 100%.

What is a Margin Call?

We cannot wrap up the topic of what margin is in Forex without explaining the margin call.

When your account balance drops, your margin level is falling. If the margin level falls under the 100 percent mentioned above, the amount on your account cannot cover the margin requirements anymore.

At that point, the Forex broker requires you to top up your margin. And afterward, you receive a margin call in the form of an alert via an email or other type of notification.

Once it happens, if you fail to fund your account, some or all of your open positions will be liquidated.

So it’s a situation you should avoid at all costs by monitoring the margin level regularly, using stop losses orders to avoid losing money, and keeping your trading account funded.

How to Calculate the Margin in Forex?

Thanks to the Forex margin calculator, determining the margin for the specific trade is easier than you think. You can find it on every Forex brokerage website today. However, keep in mind that a small commission may apply if your account currency differs from the base currency.

In Conclusion

In the Forex market, margin trading is one of the most important concepts to fully grasp in order to manage risks better, determine optimal trading positions and leverage levels. Margin trading is widespread practice since the use of leverage turns out to be very profitable.

On the other hand, you ought to be aware of the potential losses when trading on margin. Therefore, you must monitor your margin level and maintenance margin to avoid margin calls as it is the main adversity that this Forex trading strategy may incur.