Imagine yourself as a novice trader, just starting to navigate the expansive waters of FX trading. You have a boat – your initial investment and an expansive ocean to explore – the vast FX market.
However, wouldn’t it be fantastic to sail in a luxurious yacht instead of a small one, giving you a broader range and increasing potential returns?
This is where the concept of ‘margin’ steps in, acting as your upgrade from a small boat to a bigger, better yacht. Margin trading amplifies your trading capabilities, allowing you to make larger trades than your original investment permits.
Understanding and utilizing margin can become your secret weapon as a trader, catapulting you from a small fish to a big player in the vast forex ocean.
This article will explain the definition of margin, providing examples to facilitate comprehension.
What Is Trading On Margin?
Margin trading simply translates into borrowed funds from a broker to finance an investment. It’s similar to using your account’s equity as collateral for a loan, allowing you to place larger transactions or invest in more lucrative opportunities.
When you terminate your trade positions, the margin will be returned to you in a manner similar to a deposit. Although interest fees are charged when using margin, they are typically minimal in comparison to the magnitude of the transaction.
What Is The Free Margin, And How It Works?
Free margin is the account equity that is not committed to active transactions. It represents the difference between total equity and used margin. This available margin, also known as usable margin, can be used to open new positions.
Let’s now discuss the term “margin level.” The greater the margin level percentage, the greater the available trading margin.
For example, we could calculate the margin level if each open position was profitable, and we had two open positions using a total of $5,010 from a $5,000 account.
In this scenario, your account equity would equal your $50000 account balance. When $50000 is divided by $5010, the result is 9.98 multiplied by 100 to yield a margin level of 998%. A high margin level, such as 998%, indicates that you are able to initiate multiple transactions concurrently without difficulty. In contrast, a lower margin percentage implies a greater amount of used margin than equity.
Numerous brokers set the permissible minimum margin percentage at 100%. You must understand your broker’s procedures to avoid depleting your margin.
Remember that any open positions that experience a drawdown will decrease your equity, which will impact your margin level. Accounts with margin can be used for trading stocks, futures, and other assets.
What Is a Margin Call?
A margin call occurs when a trader’s market position deteriorates, and their trading balance falls below the margin trading minimum. In such situations, traders must promptly finance their accounts to maintain their position in the market. If they do not, the broker will close the position, and the speculator will be responsible for any losses.
Historically, “margin call” referred to intermediaries calling clients when their usable margin ran out or dropped below a certain threshold. With today’s sophisticated automation, brokers can notify traders via trading platforms, email, and text messages.
The margin requirement is the minimal quantity a merchant must maintain in their margin account, expressed as a percentage. This requirement varies among brokers, so validating the specifics with your brokerage is essential.
How Can A Margin Call Be Covered?
Upon receiving a margin call, your broker will inform you of the time frame within which you must satisfy it, typically three to five business days. You can satisfy the margin call by adding funds to your trading account, increasing the market position’s equity. You could also sell other assets or securities in the same account to generate cash flow and increase equity.
If you fail to respond to a margin call within the specified time frame, your broker may close your margin account or sell additional securities in the same account. The trader must repay the broker if the broker incurs losses due to a margin call.
Final Takeaway
The ability to trade on margin is a crucial feature of foreign exchange trading. Despite its significance, however, many traders have a limited comprehension of it or ignore it wholly. Margin trading can magnify your returns, for better or worse, so it is essential to comprehend margin calculations for effective risk management.