Understanding Forex Margin In Detail & How To Calculate It
With the growing popularity of forex trading, people are more aware of the amount of opportunities one can get in the dynamic forex market. Read More
In order to understand this better, you need to grasp the concept of forex margin along with its calculation in your account base currency with the help of tools like currency calculator that help in conversion by applying real-time exchange rates. You can check out this currency calculator for quick calculation – zulutrade.com/trading-tools/currency-calculator. What is the margin requirement in forex, and why is it relevant for a trader? You will get the answers to all such questions and more in this comprehensive guide about forex margin and its calculation.
How does trading on margin work in the forex market?
The concept of margin trading is pretty simple as the margin works like a collateral that needs to be there for borrowing funds when you are in need. Here, the funds will be used for placing trades based on how you expect the prices to change according to your own analysis of the market situation. Suppose you are trading with the popular major pair GBP/USD, and you are confident that the British Pound will gain in value against USD based on the recent price patterns seen in charts during technical analysis or economic indicators used for fundamental analysis.
Hence, you decide to go long by placing an order to buy the cable pair. Your account balance at the moment is $2000, as you are using USD as the account base currency. Your broker is offering up to 500x leverage, but you are only using 100x for now. Your trade size in lots is 3. Now, the broker will allow you to place trades worth $100 for every $1 you have in your account, but the margin requirement varies depending on the trading instrument, lot size, leverage and many other key factors.
Now, the calculation can be complex with all the conversions and calculations. However, you can make things easier by using a margin calculator to automate the time-consuming task. If you have a hard time finding a margin calculator, then here is a link you can open to calculate the margin – zulutrade.com/trading-tools/margin-calculator
You can simply add all the details that we mentioned above, and the result I got based on the current exchange rate is $3643.62. This means you can place these trades only after depositing the additional funds required for meeting the set margin levels, as you only have $2000 at the moment. But suppose you don’t want to deposit more and want to trade with the capital that I already have. In that case, you can think of trading just one lot and enter the same into the margin calculator, and the result I got for this is $1214.45, which means you have enough margin for the particular trade and go ahead with it.
Now, what happens if you don’t check the required margin and the account balance falls below the margin levels? Your broker will notify you about the margin shortfall with a margin call asking you to deposit additional funds to keep your trades open. All your open positions will be closed by the broker if you fail to take action in time.
But when your trading platform is offering a margin calculator like the one I have added, for example, you will be able to assess the margin requirements in advance and avoid a margin call situation for an uninterrupted trading process.
Risks and rewards of margin trading in the forex market
Why is margin trading risky?
The risk of margin trading is that you are exposed to more risk with the increase in trade size. Your margin requirement will be lower, but the actual amount of risk is directly related to position sizing, and thus, you stand at the risk of losing money you don’t have. The leverage offered by the broker will fill the trade size, but you are responsible for the consequences when there is a loss, and your account drawdown will go up when you are unable to manage this risk properly.
There will be interest charges on a typical loan, and leverage is not much different. Another risk of margin trading is the tendency to overtrade, as you will be able to place more trades with the leverage that you are availing. This can also lead to the habit of taking excess risk outside your comfort zone and risk tolerance, resulting in huge losses in the end, eating away your profits and perhaps the trading capital, too. This can make trading way more stressful for an average retail trader.
Rewards of margin trading
When there is a risk, there is also a reward, which is the rule of trading in any financial market. Those who learn to manage the risk of margin trading will be able to reap the rewards in the form of bigger profits with the amplified trade size, and you can possibly grow your trading account to a bigger scale over time. Your market exposure increases, and you can explore different trading styles requiring larger trades for optimum results. Those with enough knowledge and skills, along with a sound trading plan, can unleash their true potential through margin trading.
Those who don’t have many funds, to begin with, will still get to navigate the market and open larger-sized trades with the use of margin, which gives you an equal amount of opportunities in the dynamic forex market which you wouldn’t have gotten without sufficient funds or margin trading facility. The ability to diversify your portfolio and dive deeper into trading with more asset classes is another perk of margin trading.
What is the margin requirement in forex trading?
The margin requirement is the minimum amount of funds that need to be in your trading account for opening a trade or for keeping a running trade open. The broker will mention the margin requirement based on the instrument being traded, trade size and the account base currency. The requirement will vary based on the broker and the trading volume of the open positions. But generally, it is within the range of 0.2% to 10%. The higher margin requirement is for those instruments that are riskier and traded less. In contrast, the margin requirement for liquid instruments like major pairs is pretty low as they are heavily traded.
Relationship between leverage and margin requirement
The leverage you avail for the trade determines the trade size, and the broker specifies the margin requirement after considering the trade size. Suppose you are about to trade EUR/USD with lot size 1 and leverage of 1:1, which means no leverage. You will need $107099 as a margin based on the conversion rate at the moment. But if you are trading with a leverage of 100:1, you will only need a margin of $1070.99 for opening this position. When you increase the leverage to 200:1, the margin requirement drops to $535.5. This example perfectly describes the relationship between leverage and margin requirement.
How do you calculate the margin for your trades in Forex?
As I stated before, margin calculations can be complex and time-consuming with all the different instruments and currency conversion. However, you can save time and effort by using a forex margin calculator that gives accurate results once you enter the required data. These online calculators work using algorithms to automate the tedious calculation process and promise to return precise values instantly after converting it to your account base currency in real-time.
What is free margin?
Free margin is the money or funds in your account that can be used for opening new trades or for compensating the losses that you encounter with the existing positions. Free margin is also withdrawable, unlike the used margin, which must be in your account to keep the trades open. Free margin is also referred to as usable margin. You can calculate the free margin after deducting the leveraged funding from the total account balance, considering the profits/losses realised after closing the previous trades.
Summing Up
To sum it up, having a clear idea about margin trading and margin calculations is important to the optimum use of leverage as a forex trader. If your losses end up triggering a margin call, you will face an emergency with funding, and that is not something ideal when you have open positions. So, always make sure that your account balance is sufficient to meet the margin requirements, and always set aside some free margin to ensure the safety of your account. Always pay attention to risk management while using leverage and trade responsibly.