When trading Forex with Leverage, you need to put a small percentage of total trade volume as collateral/security to open and maintain your trade positions. Forex traders know this as Margin.
Margin is not a transaction cost or a fee for opening a trade. When you open a Trade, your Forex broker will set aside part of your fund to make sure you can afford to hold the Trade until it is closed or if the Trade results in a loss.
The Margin required by your Forex broker determines The Leverage of your trading account. Every Forex broker has different margin requirements, and it is essential to understand this before you choose a broker and start trading on Margin.
Let's say a Forex broker offers a Leverage of 1:50 or has a 2% margin requirement. Ten dollars in your account is required to open a 500 dollars worth of trade position.
Before you begin trading on the Forex market, you should have an excellent understanding of Margin. It is also important to understand although you can make a larger profit with bigger Leverage or margin requirement, it also increases the risk of losing, sometimes even your entire account balance.
It would be best to familiarize yourself with related terms like Free Margin, Margin Level, and Margin Call.
The amount of money available in your trading account which you can use to open more trades is called Free Margin. You can calculate it by subtracting the used Margin from your account equity.
Equity refers to the amount of money you have in your trading account plus or minus any profit or loss from open positions. If you do not have any open trades, the Equity will be equal to your account balance. If your open trades are losing money, your Equity will decrease, and if it is making profits, your Equity will increase. Your Free Margin will increase or decrease along with it.
Used Margin refers to the sum of all the Required Margin from all open positions on your account.
The formula of calculating Free Margin,
Free Margin = Account Equity - Used Margin
Margin level helps you understand the influence of the currently opened trades on your account. A good way of identifying whether your account is healthy or not is by making sure that your Margin Level is consistently above 100%. If your open positions are in profit, then your margin level will continue to grow as your profit increases, and it will decline if your trades are at a loss. If your margin level is 100% or below, you will no longer be able to open new trades unless the market turns in your favor and your equity increases and the Margin level along with it. If you do not have any positions open, then your Margin level will be Zero.
The formula of calculating Margin Level,
Margin level = (Account Equity / used margin) x 100
The margin call is one of the biggest nightmares for all traders, which they try to avoid at all costs. When your trades are in loss, and your margin level falls below a certain level, your broker will send you an email or push notification and request you to top up your account balance. Brokers do this to evade situations where the trader can not afford to cover their losses. Margin call level varies between different brokers, but it is 100% or below for most brokers. If you fail to top-up your account balance after receiving a Margin call and the market continues to go against you, it might result in a Stop-Out. A margin call is more likely to happen if you are trading with higher leverage.
Stop Out level and Margin call level is very similar, but it is way worse. When your Margin Level drops below a specific level, and one or all of your open positions are automatically closed/liquidated by your broker, called Stop-Out level. It happens because your trading account can no longer continue to maintain the open positions due to a lack of Free Margin. Stop-Out level Margin call level varies between different brokers, but it is 50% or below for most brokers.
You can easily avoid a Margin call and Stop-Out by carefully monitoring your account balance and using stop-loss on each order to manage your risks.