Anyone who decides that they are ready to jump into the world of Forex trading needs to know some basic facts. One of those facts is the ability to understand exactly what margin is and how it operates. We will review this concept with you today.

A Small Amount of Upfront Money

One of the most appealing aspects of trading Forex is the fact that the investor only needs to put forward a small amount of their own money to make it happen. They can front a small amount of money and use margin to get the rest of the way there on a trade. In other words, they put up a little money now and have the remainder of the trade backed up by other funds fronted to them by the broker. Those additional funds are known as margin.

An example of this is someone who wants to buy $1 million dollars’ worth of the AUD/USD pair as an example. The trader doesn’t need to come up with the full $1 million dollars to make this trade. Instead, they might have to put up as little as $20,000 of their own money to perform the trade. The broker puts up the remainder of the funds.

The margin money is still retained by the broker, but they allow the trader to borrow that money from them in order to open and keep a trade open. The trader needs to keep a certain amount of their own money in the account to maintain the margin trade though. Their money is used to buffer against losses on the trade, and their money is what will gain or decline in value as the trade moves along.

The funds that the trader puts up in their account are locked up for use during the trade. The entire time that the trader keeps the trade alive, those funds cannot be withdrawn or used for other trades. However, once the trade is exited, the trader gets their funds back (plus or minus any losses or gains), and they are free to use their money again to place another trade or to withdraw the funds.

Margin Requirements

Each currency pair has a certain margin requirement associated with the trade. This is the percentage of the trade that the trader has to front with their own money. There are some margin requirements as low as 0.25% of the total trade, and others go as high as 10% of the total trade. Much of this is determined both by the volatility of the currency pair in question as well as the requirements that the broker puts up for the trader to do what they need to do. It is highly dependent on what the broker insists upon as well as the conditions in the market as they stand today.

Required Margin

The amount that a trader has to have locked up in their trade is the required margin. If the pair being traded as a 2% required margin level, then the trader must put up at least 2% of the amount that they would like to trade. In other words, a trader who wants to trade $100,000 worth of EUR/USD would need to have at least $2,000 in their account to make that happen. Anything short of that, and they are not going to meet the margin requirements to keep themselves in the good graces of the broker and of regulators. It is completely necessary for them to put forward the full amount of margin to make the trade at all. In fact, the vast majority of brokers will not allow traders to execute trades that don’t have the required amount of margin tied up in them.

Required Margin Example

If you were to trade the USD/JPY for one mini lot ($10,000 worth of the pair), you would need the 4% required margin to open this trade. You would have to agree to have $400 of your balance locked up for the duration of the trade.

 

In the event that the trade moved against you to the tune of $400, then you could have a margin call that automatically shook you out of the trade. It is important to understand where you stand with these trades as you don’t want to let margin calls swamp you out of good trades. People sometimes forget to deposit enough money into their accounts to keep themselves afloat even when times get tough. Now that you know a little about what margin is, you should try to ensure that you never put yourself in a spot where you have a margin call go against you. You would lose your margin for the trade, and you may get taken out of the trade right before it makes a turn in your favor.

Calculating Required Margin

Tabulating the required margin for a specific trade is easier than you might think. You just need to figure out how much of a position you want to take in a certain currency, then figure out the percentage of margin requirement that currency has, and then calculate from there.

When trading with margin, the amount of margin (“Required Margin”) needed to hold open a position is calculated as a percentage (“Margin Requirement”) of the position size (“Notional Value”).

Required Margin = Notional Value x Margin Requirement

The amount that you will have to agree to have locked up is very simply the percentage of the total amount of the currency that you would like to trade. You can get away with depositing a fairly small amount of money to make this happen, but you need to ensure that you always have enough to cover your trades at all times. Don’t let yourself get margin called out.