Understanding Forex Margin And Leverage
Forex Margin and Leverage are two of the most important aspects to understand, to get started with trading. These two terms are often confusing for traders, but understanding forex margin and leverage is essential, especially when it comes to position size or risk management. By the end of the article you should be able to have a better understanding of these terms, which should in turn help you to make the right decisions while managing your trading account.
classic questions such as the following are answered once you understand the concepts of margin and leverage:
-What leverage should I choose?
-What is the ideal position size to open?
What is margin in trading?
Margin trading, or trading on margin are similar terms which mean that a trader needs only to deposit a certain amount of their equity as a collateral for holding a trading position, instead of having to put up the entire amount. The way margin is determined is based on the leverage that you choose. Margin is typically expressed as a percentage.
What is leverage?
Leverage in forex is expressed as a ratio (ex: 1:50) and allows traders to trade higher volumes without having to put up the required collateral in its entirety. In other words, leverage allows traders to magnify their positions, to levels that would be impossible with their original capital. For example, 1:50 leverage means that for every $1 a trader has in trading capital, they can trade up to $50 using the said leverage ratio. Leverage ranges from 1:1 (no leverage) and can go as high as 1:500 depending on the leverage choices offered by your broker.
How does leverage and margin work? (Part 1/2)
For example, if you were to choose a leverage of 1:100, then for every $1000 in equity, you can trade up to $100,000 units, which is one standard lot in forex terminology.
The table below gives a brief summary of the positions you can hold by using a hypothetical amount of trading equity of $5000.
The minimum margin amount or collateral required to control a position size of 1 standard lot for leverage of 1:100 is $1000. In order to manage your trades better, you need to have your account funded, in excess of the margin requirement. The margin amount is locked in, and deducted from your trading balance for as long as your position is open. If your trading equity falls below the margin amount, it results in closing out all open positions, which is also known as a “margin call”.
How does leverage and margin work? (Part 2/2)
To better explain this, let’s look at another example.
You have a starting Capital of $5000
You choose a leverage of 1:100
This means that you can trade up to $500,000 or 5 standard lots. However, note that your trading account should be in excess of the margin amount. Therefore, you can trade 1 standard lot ($100,000), where $1000 is locked in as margin collateral, leaving you with $4000 in trading capital.
Margin requirements can vary from one asset to another. For example, it is common to find a 100% margin requirement on major forex currency pairs, while CFDs on commodities such as oil and gold require a 50% margin.
How to calculate Margin?
Your leverage is 1:300
You bought 0.10 lots (10,000) EURUSD at 1.10098
The total collateral required to fund this position would be 10,000 x 1.10098 = $11009.8
Now divide the total position $11009.8 by the leverage of 300, which would be $36.7
Required Margin = (Bid or Ask price (Sell or Buy price) x Lots)/Leverage
Margin Call and Stop Out levels (Part 1/2)
A margin call is a warning issued by your broker, alerting you that your available equity or free margin has fallen below the required margin percentage to support the open positions. When you get a margin call, you can either close your least profitable trades, or fund your account so your free margin is above the required margin percentage.
Following a margin call, the stop out level is where your positions start to be closed automatically, starting with the least profitable trade. Some brokers use the same margin call and stop out levels, while some tend to have a higher margin call and a lower stop out level.
Margin Call and Stop Out levels (Part 2/2)
Examples:100% Margin Call means that when your free equity falls below 100% of the required margin your trades are closed out 30% Margin Call and 20% Stop out level
means that when your free equity falls to 30% of the margin, you are issued a warning to fund your account or manage your losing positions.
If the free equity falls to 20% of the margin, your trades are closed out immediately
Margin Level = (Equity / Margin) x 100
How to check your margin and leverage on MT4
To check on the margin requirements in your MT4 trading platform, click on “Market Watch” to display the instruments/symbols. Then, right click on any instrument and choose “Specification” which will show the individual margin requirements.
To find out your account leverage, hover with your mouse over your account number by opening “Navigator” which will display your leverage.