As you get ready to start trading currency you will most likely go through quite a bit of educational materials. Depending on the level of your previous knowledge about Forex, it might take anywhere from a couple of days to a few weeks to get familiar with all the technicalities. One of the most common difficulties when it comes to understanding the nature of currency trading, is familiarizing yourself with dozens of specific terms. The bigger portion of the terminology is going to be pretty self explanatory, however, there are still going to be a certain amount of words that will seem unclear. Your main task during the studying process is to make sure that you know exactly what do they mean in order to become successful. In this article we are going to focus on the specifics of what is margin in Forex and how does it work.
You might know by now, that in order to trade with high amount you do not necessarily need to have it available. For example, you can begin by depositing 1000 dollars and getting an opportunity to enter the market with 100,000. It does not make much sense at first, but there is a very simple explanation for that. Which brings us to the initial question: what is margin and leverage in Forex? It is important to mention, that although both these terms have a very different meaning they are closely associated with the same aspect of trading. So, what exactly do they mean.
Leverage is widely used by new traders, as well as by experienced ones. It is simply the ability to have your initial investment “multiplied” by the broker. The size of the leverage will depend both on your particular broker and on the agreement that you have with them. Needless to say, that the bigger the leverage the higher amount will be available to you for trading. Now, while it sure does sound like a win-win type of situation, it is important to keep your caution while using leverage. Of course, your return rate is great, but it is also directly proportional to the return rate in the scenario when you lose. That way a 100% turns into -100%. That should not discourage you in any way, because when used correctly and systematically leverage can serve as an effective tool.
Now, in order to provide you with whatever leverage the broker is required to hold a certain amount from your account. That brings us to exploring what is margin balance in Forex. Remember that 1000 from earlier that magically became 100,000 via leverage? Well this is exactly what margin is. It is an amount provided as collateral to open and hold any new position while trading. Do not think of it as a fee, as it is not charged off your account, but simply held aside as a deposit for every specific trade. Margin is usually presented in a form of a percentage of the total amount. Again, this percentage will vary based on your agreement with the broker. It can be as low as a quarter percent to ten percent and higher. The margin can be referred to as required margin, initial margin, deposit margin or entry margin. Despite the many names, it always means the same - an amount held aside by the broker in order to be used as collateral.
Let’s briefly go over a few other terms including the word margin, so you get a fuller picture. For example, what is margin free margin and margin level in Forex? The types of margins in your account can be separated into two groups: the margins currently held up in trades, and the margins available to be used. Those available ones can be referred to as free margins, or in other words, unused margins. The amount of free margins can be calculated by determining the margin level, which is a value based on the relations between equity and used margin expressed as a percentage. Your trading platform will calculate this percentage automatically, and the lower this percentage the less unused margins are available to you. Note, that the margin level will indicate as 0% when there are no open trades.
Another indicator that involves the concept of margins is a margin call. This happens when you do not have enough funds in your account to cover the potential loss. In that case the broker will close a few or all of the currently open positions at the market price. And as you might have already guessed, you will need to make another deposit to increase your equity and therefore your margin level.