Although most trading platforms calculate profits and losses, used margin and usable margin, and account totals, it helps to understand how these things are calculated so that you can plan transactions and can determine what your potential profit or loss could be. Most forex brokers allow a very high leverage ratio or, to put it differently have very low margin requirements. This is why profits and losses can be so great in forex trading even though the actual prices of the currencies themselves do not change all that much.
Using margin in forex trading is a new concept for many traders, and one that is often misunderstood. Margin is a good faith deposit that a trader puts up for collateral to hold open a position. More often than not margin gets confused as a fee to a trader. It is actually not a transaction cost, but a portion of your account equity set aside and allocated as a margin deposit. When trading with margin it is important to remember that the amount of margin needed to hold open a position will ultimately be determined by trade size. As trade size increases your margin requirement will increase as well.
Margin is the amount of money needed as a “good faith deposit” to open a position with your broker. It is used by your broker to maintain your position. Your broker basically takes your margin deposit and pools them with everyone else’s margin deposits, and uses this one “super margin deposit” to be able to place trades within the inter-bank network. For example, in forex, to control a $100,000 position, your broker will set aside $1,000 from your account. Your leverage, which is expressed in ratios, is now 100:1. You’re now controlling $100,000 with $1,000. The $1,000 deposit is “margin” you had to give in order to use leverage.
Margin is usually expressed as a percentage of the full amount of the position. Based on the margin required by your broker, you can calculate the maximum leverage you can wield with your trading account. Aside from “margin required”, you will probably see other “margin” terms in your trading platform. Used margin: The amount of money that your broker has “locked up” to keep your current positions open. Usable margin: This is the money in your account that is available to open new positions.
Margin call: You get this when the amount of money in your account cannot cover your possible loss. It happens when your equity falls below your used margin. If the market moves against a trader resulting in losses such that the trader lacks a sufficient amount of margin, there is an automatic margin call. The forex dealer closes the trader’s positions and limits the losses for the client because this stops the account from turning into a negative balance.