It is one of the most enticing and yet most misunderstood aspects of trading Forex, and that is margin trading. Most would-be traders have heard of these words before, but many are unclear as to what they actually mean. Luckily, we have the breakdown for you today.
Let’s start by making this simple point: Margin trading gives you the option to trade in positions much larger than the amount of money in your account!
That’s right, you have the opportunity to trade in amounts that you would think only the big-time players could trade. This is because a margin account allows you to trade with money that is not currently in your account. Isn’t this risky? You might ask yourself, and the answer to that question boils down to how much risk you personally decide to put on your trades. The good news though is that even though you are trading on margin, you are still limited to losing just what is in your account.
An Example of Margin Trading
Let’s say you deposit $1,000 into your account to begin trading. You decide to trade in a currency pair that requires 4% margin to place a trade. In this case, you decide that the EUR/USD is the pair for you. You would like to trade $10,000 worth of the pair, but you only have $1,000 in the account. The way to get around this? Margin trading. Instead of putting up the full $10,000 to place the trade, you are only required to put up $400 worth of locked funds to make the trade.
What this means is that $400 of your $1,000 balance will be locked up in margin for the duration of your trade. If your trade moves in your favor, you will see your balance start to climb, and you can make the choice to exit the trade at any point in time. If the trade moves against you, then you will see your balance start to decline. If it moves against you enough to wipe out the $400 that you have put up in margin, then your trade will be wiped out via a margin call, and your original $1,000 balance will drop sharply. It can be quite jarring to someone who has never executed a currency trade before, but that is how the margin game works. It plays to your advantage on winning trades, and it can be costly on losing trades.
The following are all interrelated:
- Margin Level
- Used Margin
- Free Margin
- Unrealized P&L
The value of your account before taking into account any open positions.
The current value of your account including the value of any open positions.
The amount of money you need to have, and maintain, in your account to cover any open positions.
The ratio of Equity to Margin, calculated by the following formula:
( Equity / Margin ) x 100 = Margin Level
The difference between your Equity and the Margin.
The balance, including the current result of all open trades.
Always Keeping an Eye on Your Balance
What you can get really excited about is the opportunity to always have a chance to see what your current balance is at any given time. Any broker worth their salt will have this feature readily available to their users on demand. What this means is that the trader can look up and see how their account is doing as their trades are still in motion. They get to see at any given moment what their balance would be if they were to exit all of their trades at that time. There is no need to get out a calculator or try to figure out all of the math behind the margin numbers yourself when you can simply work this all out by looking at the balance bar provided by the broker.
Any trader can see his or her cash balance as well as the value of their entire account all from the same screen when they use a broker that is providing them with the tools that they need to be successful. There is absolutely no reason why people shouldn’t have the ability to get into the numbers like this, and most platforms worth trading on will provide these figures.