Margin Trading Explained

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Margin in Forex trading

The Forex market is one of a number of financial markets that offer trading on margin through a Forex margin account. Many traders are attracted to the Forex market because of the relatively high leverage that Forex brokers offer to new traders. But, what are leverage and margin, how are they related, and what do you need to know when trading on margin? This and more will be covered in the following lines.

Margin Forex definition

Trading on margin refers to trading on money borrowed from your broker in order to substantially increase your market exposure. When opening a margin trade, your broker lends you a certain sum of money depending on the leverage ratio used, and allocates a small portion of your trading account as the collateral, or margin for that trade. The remaining funds in your trading account will act as your free margin, which can be used to withstand negative price fluctuations from your existing leveraged positions, or to open new leveraged trades. The relation between your free margin and other important elements of your trading account, such as your balance and equity, will be explained later. For now, it’s important to understand the meaning of margin in Forex.

What does margin mean in Forex trading?

As we’ve already stated, trading on margin is trading on money borrowed from your broker. Each time you open a trade on margin, your broker automatically allocates the required margin from your existing funds in the trading account in order to back the margin trade. The precise amount of allocated funds depends on the leverage ratio used on your account.

Relation between leverage and Forex margin explained

The first time you open a trading account with a Forex broker, chances are that you’ll see the available leverage ratios which are offered by the broker. Many brokers use leverage ratios for marketing purposes, as higher leverage ratios allow you to open a much larger position size than your trading account would allow.

Popular leverage ratios in Forex trading include 1:10, 1:50, 1:100, 1:200, or even higher. Simply put, the leverage ratio determines the position size you’re allowed to take based on the size of your trading account. For example, a 1:100 leverage allows you to open a position 10 times higher than your trading account size, i.e., if you have $1,000 in your account, you can open a position worth $10,000. Similarly, a leverage ratio of 1:100 allows you to open a position size 100 times larger than your trading account size. With $1,000 in your trading account, you could open a position worth $100,000!

Since the leverage ratio determines the Forex margin requirements, here is a table that showcases the required margins depending on the leverage ratio used.

MARGIN REQUIRED

LEVERAGE RATIO

As you can see, the higher the leverage ratio used, the less margin you need to allocate for each trade.

Trading on leverage carries risk

You could ask yourself, why wouldn’t you use the highest leverage ratio available in order to decrease your margin requirements and get an extremely high market exposure? The answer is rather simple and deals with Forex risk management. While leverage magnifies your potential profits, it also magnifies your potential losses. Trading on high leverage increases your risk in trading.

Let’s cover this with an example. If you have $1,000 in your trading account and use a leverage of 1:100 you could theoretically open a position size of $100,000. However, by doing so, your entire trading account would be allocated as the required margin for the trade, and even a single price tick against you would lead to a margin call. There would be no free margin to withstand any negative price fluctuation.

Now, let’s say you open a trade worth $50,000 with the same trading account size and leverage ratio. Your required margin for this trade would be $500 (1% of your position size), and your free margin would now also amount to $500. In other words, you could withstand a negative price fluctuation of $500 until your free margin falls to zero and causes a margin call. Your position size of $50,000 could only fall to $49,500 – this would be the largest loss your trading account could withstand.

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Margin, free margin, balance, and equity explained

Now that we’ve defined margin in Forex trading, let’s take a look at the various elements of your trading account and how they are being affected by the leverage ratio and margin requirement. It’s extremely important to understand how these elements are intertwined, in order to create a sound risk management strategy.

Equity – Your equity is simply the total amount of funds you have in your trading account. Your equity will change and float each time you open a new trading position, in such a way that all your unrealised profits and losses will be added to or deducted from your total equity. For example, if your trading account size is $1,000 and your open positions are $50 in profit, your equity will amount to $1,050.

Balance – Your trading account balance equals your equity only if you have no open positions. In other words, unrealised profits and losses do not impact your balance. Only when you close your trades and the unrealised P/L become realized will your trading account balance change.

Margin – As you already know, the amount of margin on your account depends on the size of your open positions and the leverage ratio used. Your broker automatically allocates a certain amount of funds in your trading account as the margin each time you open a leveraged trade.

Free Margin – Your free margin represents your total equity minus any margin used for leveraged trades. For example, if your equity is $1,000 and your used margin is $100, your free margin would amount to $900. Following your free margin is extremely important, as it is used to withstand negative price fluctuations from your open trades and to open new leveraged trades. It’s important to understand that your free margin increases with profitable positions, but decreases with your losing positions. Once the free margin drops to zero or below, your broker will activate the so-called margin call and close all your open positions at the current market rate, in order to prevent your equity from falling below the required margin.

Unrealized P/L – Finally, unrealised profits and losses are all profits and losses made on open positions. They impact both your equity and free margin. Once you close your open positions, unrealized P/L become realised.

The relationship between all mentioned categories of your trading account can be expressed using the following formula:

Equity = Margin + Free Margin OR Equity = Balance + Unrealized Profits/Losses

Monitoring your available margin

Your available margin (free margin) determines the number of negative price fluctuations you can withstand before receiving a margin call. It also impacts the amount of new leveraged trades you’re allowed to take. Monitoring your free margin is therefore very important, as you don’t want this category to drop to zero.

Each time you open a new trade, calculate how much free margin you would need to use if the trade drops to its stop loss level. In other words, if your free margin is currently $500, but your potential losses of a trade are $700 (if the trade hits stop loss), you could be in trouble. In these situations, either close some of your open positions, or decrease your position sizes in order to free up additional free margin.

What are margin calls and how to prevent them

Margin calls are mechanisms put in place by your Forex broker in order to keep your used margin secure. Remember, your used margin is allocated by your broker as the collateral for funds borrowed from your broker. A margin call happens when your free margin falls to zero, and all you have left in your trading account is your used, or required margin. When this happens, your broker will automatically close all open positions at current market rates.

Final words on margin in Forex trading

Trading on margin is extremely popular among retail Forex traders. It allows you to open a much larger position than your initial trading account would otherwise allow, by allocating only a small portion of your trading account as the margin, or collateral for the trade. Trading on margin also carries certain risks, as both your profits and losses are magnified.

If your free margin drops to zero, your broker will send you a margin call in order to protect the used margin on your account. Always monitor your free margin to prevent margin calls from happening, and calculate the potential losses of your trades (depending on their stop-loss levels) to determine their impact on your free margin. With some experience, you’ll find it significantly easier to follow your margin ratio and understand the meaning of margin in Forex trading.

Margin Trading, Explained

This is where you make trades using money borrowed from someone else – or a brokerage.

While the potential rewards can be high, there are some sizeable risks that investors need to contend with too.

Let’s start with an example using dollars. Imagine you have $50. Margin trading is where you leverage $500 based on this sum of money in your pocket.

As you’d imagine, the principle in the cryptocurrency world is quite similar. Let’s say you want to buy Ethereum worth $1,000, but you’ve only got $500 available. Through margin trading, you’d be able to borrow an extra $500 – getting you up to the magic total.

If your $1,000 in Ethereum grew in value, to say $1,500, you’d be able to liquidate it and return the $500 to the lender, leaving you with a gross profit of $500.

Of course, the value of cryptocurrencies can go dramatically down as well as up. In a scenario where the price of Ethereum went down by 50 percent, your lender would be able to get their $500 first before you can access funds, potentially leaving you with nothing.

I’ve heard of long and short positions. What are they?

These two terms relate to whether a trader thinks a cryptocurrency is going to rise or fall in value.

“Going long” generally means that you believe the Bitcoin or Ethereum you’ve just purchased will rise in value over time – and through leveraging, this can amplify your gains (and amplify any losses you make.)

On the flipside, you might believe that one of these cryptocurrencies is about to experience a fall in value – and this is where a short position comes in handy. As an example, let’s imagine you think that Bitcoin, trading at $7,000, is going to drop in price. Here, you sell your Bitcoin for $7,000 – and then buy it back when it tumbles to $6,400. Once this transaction has been completed, this represents a gain of $600.

What are the most common risks with margin trading?

The fact that many cryptocurrencies are so volatile means margin trading is only recommended if you’ve done your homework and have experience.

Losing your own money when trading in crypto can be unpleasant enough without the borrowed funds of other investors coming into the equation.

The main risk to remember is that you have the potential to lose your whole initial investment through margin trading, especially if your focus has been on altcoins with a low volume and high volatility.

If one of your trades starts to lose money, your margin can be “called in.” Let’s say you are margin trading with a ratio of 2:1, where every dollar you’re investing is matched by someone else. Here, your position would be liquidated when the value falls by about 50 percent in order to preserve the lender’s funds.

It is possible to inject further cash to prevent this from happening, but this can cause substantial losses to pile up quickly. Sometimes, it’s about knowing when to cut your losses.

Are margin trades regulated?

They are regulated with uniformity on conventional stock exchanges – but the rules can vary between crypto platforms.

This may all be about to change. For example, as reported by Cointelegraph, Japan’s Virtual Currency Exchange Association (JVCEA) wants to limit the amount that margin traders can borrow – enforcing a cap that stands at four times the amount of their investment.

Explaining their plan to a Chinese media outlet, the JVCEA said: “It aims to prevent investors from suffering a lot of losses due to sudden price fluctuation of the virtual currency.”

Regulatory compliance has become something of a priority after the Coincheck exchange was a victim of a massive hack back in January, with 523 million NEM coins worth $534 million being lost back in January.

Other major exchanges, such as OKEx, already cap leveraging to three times the amount of capital that an investor has. Kraken offers up to five times leverage, but only to users who have verified their identity. The number of pairings it offers is currently restricted, and pairings involving euros are not available in some US states.

Coinsbit, a new trading platform, is also planning to introduce margin trading by the end of the year — along with crypto loans in U.S. dollars. The company is hoping to stand out from the hundreds of other exchanges by tackling the security and liquidity concerns that traders face, as well as high transaction fees. More than 95 percent of all currency is stored in cold wallets. Web Application Firewall (WAF) — a protective screen of a web application — detects and blocks hacker attacks. Coinsbit is currently working to get listed on CoinMarketCap.

Any tips for getting the best results?

First and foremost, remember that it’s your money at stake.

Generally, margin trading should be considered as a short-term investment – not least because of the wild volatility that often grips the crypto market.

You should never invest more than you can afford to lose, and it’s always worth setting limits that will automatically pull you out of an investment whenever it falls below a certain level. Similarly, setting profit targets also ensures that you exit a trade at the optimal time.

Once again, this is an advanced activity that should not be entered into lightly.

You should always factor in any costs that may arise as part of your margin trading – such as platform fees and interest rates to lenders – and it’s always worth gaining experience and confidence through trading with your own money first.

Is margin trading available on all crypto exchanges?

Most of them – but not all.

As we mentioned earlier, the likes of OKEx and Kraken have rolled out this feature, but some of the bigger crypto exchanges such as Binance do not offer margin trading at present. Huobi activated margin trading back at the start of 2020, and this service is also available through HitBTC, Bitfinex and Bithumb.

Cointelegraph recently reported that Bakkt, the upcoming regulated ecosystem for crypto assets around the world, will also not support margin trading – and says its platform is meant to ensure that “the buying and selling of Bitcoin is fully collateralized or pre-funded.”

Disclaimer. Cointelegraph does not endorse any content or product on this page. While we aim at providing you all important information that we could obtain, readers should do their own research before taking any actions related to the company and carry full responsibility for their decisions, nor this article can be considered as an investment advice.

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Margin in Forex Trading Explained

What is Margin?

Margin trading in forex is trading with a loan borrowed (short-term loan) from a broker to control large positions on a currency pair.
A margin is the amount of money a broker will put aside to keep investor’s trading position(s) open.

However, it simply magnifies the amount of profit or loss on a trading account. The margin (loan) on a forex trading account is equivalent to the leverage of that account. The leverage on the margin account determines the margin level or percentage on the account.

Consequently, margin level reduces as more trader place more positions. As the positions traded closes into profit, the margin level increases (good for the trading account).

Margin Call

When the positions traded closes into a loss, the margin level decreases (account may soon get a margin call). Margin increases with increase in position traded (increase in lot size traded increases the margin).

Moreover, an investor that wants to trade up to $10,000 on a mini trading account (for example, with leverage ratio 100:1), he or she will require a 1% margin which is equivalent to $100 as the investment capital to be deposited to the trading account plus $9,900 as free margin from the broker.

Basically, the implication is, if a broker requires 1% margin (the trader will have a leverage ratio of 100:1) on a $100 deposit (which is the margin), the trader can trade up to $10,000 ($9,900 will be a free margin from the broker).

For instance, 1 lot of the currency pair traded will be $100 and if the trader opens several positions up to 50 lots, this means the trader is traded up to $5,000 (the remaining free margin will be $4,500).

However, if the broker requires 2% margin (the trader will have a leverage ratio of 50:1) on a $100 deposit (the margin), the trader can trade up to $5,000 ($4,900 will be a free margin from the broker).

Another instance is, if the broker requires 0.5% margin (the trader will have a leverage ratio of 200:1) on a $100 deposit (the margin), the trader can trade up to $20,000 ($19,900 will be a free margin from the broker).

Generally, if trade position worsens and the free margin drops from the initial $9,900 to $0 (the trading account is left with $100 margin which is equivalent to the initial deposit by the trader) the broker will initiate a margin call.

Basically, the trader is either advised to deposit more funds to the trading account or to close all the trading positions to limit risk. Failure to close all the open positions, some brokers will automatically close the positions to an acceptable limit while other will allow the trading account to run to zero balance.

As the account runs into losses, and equity falls below the margin, the trading account gets a margin call.

MT4 Terminal Margin formula
Margin + Free Margin = Equity
Equity/Margin x 100% = Margin Level
Margin call = Free margin drops to zero
Investing in a margin account comes with risk.

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