Margin, Leverage and Margin Call

Education / 5 Min Read
02 Dec 2020

What is Margin and Margin Trading?

The forex market is the largest financial market globally, with an estimated daily trading volume of $6.6 trillion. This makes it very attractive for anyone wanting to try and profit from it, however, before jumping in, there are some critical concepts that potential new traders need to grasp. And one of the most important concepts you must understand is margin.

Before being able to trade, a trader needs to put an initial sum of money (otherwise known as capital) into their trading account. Margin is a portion of your funds set aside from the account balance to keep positions open or to maintain them, which effectively acts as a deposit or collateral that is placed with a brokerage. Moreover, the amount of margin you need to have in your account in order to trade varies between forex brokerages. 

Understanding margin is important because it’s directly associated with margin trading. Margin trading uses a portion of your own trading capital, while borrowing the remaining amount from the broker so that you can trade different assets including forex, indices and commodities. 

As a forex trader, utilising margin allows you to get access to more and larger opportunities when compared to only using your own capital. This makes margin trading one of the essential trading methods employed by traders, regardless of their experience.

Leverage

When you use margin, you are given leverage for your trading, which goes together with margin trading; you’ll see this expressed as a ratio like 20:1, 50:1 or 100:1.

Let’s look at an example to see how it works.

Suppose a trader has $500 in their account but feels that’s not enough to trade with. They might then opt to use the leverage provided by a broker. If they chose to use 50:1 leverage, their investment potential would turn into $25,000 (500 X 50). The broker will take a certain amount as margin - which varies between the different trading instruments - and essentially lend you the rest to enable you to open the position.

The benefit of leverage is that it gives traders the ability to enter and control larger funds using a small margin. This is appealing to many forex traders, but it is important to remember that margin trading and leverage can be a double-edged sword as they can magnify both wins and losses.

How much leverage to use?

One of the mistakes new traders make is to use a high level of leverage, thinking they will make huge profits very quickly. While this is a possibility, the opposite scenario can also happen. If the market turns against your trade, it’s possible to suffer big losses and, in some cases, accounts have been wiped out (closed out) due to high leverage.

To counter this, it’s advisable for beginner level traders to use a smaller leverage ratio until they get familiar with trading, and gain more confidence in their ability. This serves as a risk management strategy, which provides more room to trade without risking too much of your capital.

Use this table to understand and calculate margin requirements and levels of leverage:

Leverage

Traded Amount

Margin Required

Margin Required As %

1:1

$100,000

$100,000

100%

2:1

$100,000

$50,000

50%

10:1

$100,000

$10,000

10%

50:1

$100,000

$2000

2%

100:1

$100,000

$1000

1%

200:1

$100,000

$500

0.5%

400:1

$100,000

$250

0.25%

What is a margin call?

A margin call is definitely one kind of “call” you don’t want to get! Once upon a time it actually was a phone call, but these days it’s an email alerting you that the available margin in your account is getting dangerously low.

A margin call happens when the account value falls below the broker's required minimum value. When this happens, the broker will require the trader to deposit additional funds into their account to balance the minimum maintenance margin, which varies from broker to broker.

What is a stop out level?

If a margin call is not met, it enters a stop out level. The stop out level is a specific level at which all active positions are closed by the broker, because they can no longer be supported due to insufficient margin levels. The broker may close out any open positions to bring the account back up to the minimum value, without the trader’s approval. Do note that this process is usually not possible to stop as it is automated. The broker may also charge a commission on the transactions, with the trader being responsible for any losses sustained during this process.

This is a worst case scenario and it typically stems from bad trading habits, commonly overlooked mistakes, and insufficient risk management.

Regardless of your experience with forex trading, you can protect yourself to a degree by using stop losses for any open positions – especially for scenarios when the market moves violently against you. Similarly, you should always ensure you have enough funds in your account and don't enter into trades that are too large relative to the amount in your account.

How to monitor margin levels?

Using the Market Watch view on the MT4 trading platform, it’s easy to monitor the available margin level in a trading account. Using this view, you can quickly track all the relevant information – such as account balance, free equity and available margin – and  use this to manage margin levels accordingly.

How to calculate margin requirements?

Forex brokers offer different margin requirements, so it’s a good idea to check the margin requirements of the FX broker. After that, calculating the margin requirements is easy: all you need to do is multiply the amount of trades you want to open by the margin. 

For example, let’s say you want to enter a $10,000 trade at 3.5% margin. You multiply 10,000 X 3.5% = $350. This means you need to have $350 (at a minimum) in your account to open the trade. For more information on Axi’s offerings, please view it here! 

Final thoughts

When used properly, and as part of the overall risk management strategy, margin trading can be a very effective tool in your trading kit. It helps manage and optimise trading capital and lets you take advantage of multiple trading opportunities – and the same is true with leverage. Just remember that both margin trading and leverage can magnify wins and losses, so use them responsibly!

The information is not to be construed as a recommendation; or an offer to buy or sell; or the solicitation of an offer to buy or sell any security, financial product, or instrument; or to participate in any trading strategy. Readers should seek their own advice. Reproduction or redistribution of this information is not permitted.

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