What Is Margin In Forex
If you’re a newcomer to forex, the term “margin” is one of many examples of trading vocabulary that you’ll encounter while browsing forex forums or YouTube channels. You might have little idea about margin to start with, but still feel excited about the prospect of making money by trading online, so you decide to do some research to understand the basics. This article will help you to achieve this knowledge by explaining what margin is, how it works, and what it means for your trading.
What is Margin?
“Margin” is an amount of money used as a deposit, to allow you to open a position with your forex broker. This part is separated from your main trading account and held by the broker in a combined margin account. Your margin money will be returned to your account after your trade is finished or your position is closed.
For example, you have an account of $5,000, and the broker says they require a 0.5% margin for a $100,000 position. This means to open your position or join the trade, you have to “deposit” 0.5% of $100,000, or $500. You use your $500 to control the total $100,000.
Why Should We Trade on Margin?
Many beginner investors will ask this question when they read the above example. Let’s see another one:
Imagine that you want to trade the EUR/USD currency pair and the current rate is 1.2500; you use $500 to buy EUR. And in a positive situation, the rate rises to 1.2520. Now, your $500 also grows:
500 x (1.2520 – 1.2500) = $1
$500 in this example will give you only $1 profit. But if you use all of your money (but don’t do that for real – it’s just an example), the profit you receive in this scenario is:
5,000 x (1.2520 – 1.2500) = $10
So, your $5,000 of investment only brings you $10; a tiny return, not worth your time and effort. But what happens if the investment is $100,000?
$100,000 x (1.2520 – 1.2500) = $200
Doesn’t it sound more interesting? It is even better knowing that you can make that $200 with your $500 deposit. You use only $500 to trade on the full amount of $100,000 – which is known as leverage of 1:200. Taking a mathematical perspective, you can learn that the change in the rate of a currency pair normally occurs in the last 2 digits; thus, only a tremendous amount of buy-in money like a “lot” or $100,000 or bigger can make a significant profit or loss in bad case. However, not many of us are millionaires who can afford these amounts, and that’s how margin works: multiple investors bid, and the broker combines them into a full one.
Other Relevant Terms
After these two examples, you may understand a little about margin, why we use it and how it works. Now, it’s time to get familiar with other “margins”:
· Account margin: The total amount money in your trading account, normally known as your balance.
· Required margin: The amount of money that a broker needs from you to open your position.
· Used margin: The amount of money that you have used to open your one, two or more positions. As mentioned in the first section, these deposits are temporary and will be returned when you’ve closed your position.
· Usable margin: The money left in your account which can be used for other trades.
· Equity: “Hey, it’s not about margin”, you might say. I know, but this is an important term before you learn about the next: “margin call”. Equity is the live account balance, so it often fluctuates within the trade, whereas the account balance will only be calculated and settled after the trade.
· Margin call: This is a notification informing you that the available money in your account cannot meet the possible loss. You will receive a margin call when your equity is equal or less than used margin.
You should now understand the term “margin” in Forex. Please remember that there are many other forex terms that are also linked, so remember to continue your forex research to understand as much trading terminology as possible, before you begin to trade.