Understanding what margin is, and using leverage safely, is vital for all forex traders.

This is because leverage plays a vital role in forex trading, or any other form of trading where CFDs are used.

In this guide to margin and leverage in forex trading, we’ll tell you all you need to know to trade safely and keep your risk under control.

What are leverage ratios?

The leverage ratio available may depend on the currency pair you are trading.

For instance, a leverage ratio of 10:1 enables you to control a position ten times larger than your initial investment.

This means if you have $100 in your trading account as margin, you can open a position worth $1,000.

Put another way, a margin requirement of 1% means you will only need to have 1% of the trade value in your trading account.

Let’s look at a specific example:

Let’s say you have a $10,000 trading account and your broker offers 50:1 leverage.

This equates to a 2% margin requirement. Therefore, to open a USD $100,000 forex position, you’d only need to deposit $2,000.

The $2,000 is your required margin amount.

Your broker effectively ‘lends’ you the remaining $98,000, giving you control over a much larger position than you would be able to purchase if you didn’t have a leveraged account.

Understanding margin levels

Margin level refers to how much of a trader’s own equity is being used. It is expressed as a percentage.

It’s calculated as follows:

Margin Level = (Equity / Used Margin) x 100

Used margin is the amount in your trading account that is being used as a security deposit.

A higher margin level (over 100%) signifies you have more funds available to use to open additional trades.

Let’s look at a specific example:

Let’s say you deposit $10,000 into your forex account

Your broker offers 50:1 leverage, meaning there is a 2% margin requirement

To open a $100,000 USD/JPY position, you’d put up $2,000 (2% of $100,000) as margin

This leaves $8,000 ($10,000 – $2,000) of usable equity in your account

Your ‘used margin’ in this case is $2,000

If the maintenance margin requirement is set at 50% of the initial margin (which is common), then the minimum equity you need to maintain is $1,000 ($2,000 initial margin * 50%).

In this scenario, as long as the value of your position doesn’t cause your account equity to fall below $1,000, your position remains open, and you can continue trading.

Maintenance margin, margin call and closeout

Maintenance margin refers to the minimum margin required to keep a position open.

In the above example this would be $2000.

When a trader’s account equity falls below 100% of the maintenance margin, it triggers a margin call, indicating you are getting close to the level where you will no longer have funds to maintain an open position.

In the above example, a margin call would be triggered when the account equity equals $2000, the same as maintenance margin.

A margin call is when a broker contacts the trader to notify them their available funds are insufficient.

This will usually be in the form of an email notification to the trader.

To rectify a margin call, a trader may deposit additional funds immediately, or they risk having their position liquidated.

This is called a margin closeout. It occurs when the account equity reaches 50% of the required maintenance margin.

In the above example, a margin closeout would occur when the account equity reaches $1000 (50% of the $2000 required margin).

How does a margin call work?

A margin call is a notification that your account lacks sufficient funds to maintain your current open position.

This is how a margin call works:

In our scenario above, imagine the USD weakens against the Japanese Yen, causing a decrease in the value of your position, causing a loss of $8000.

This decrease leads to a decline in your account equity to $2000.

Your equity has now fallen below the minimum maintenance margin requirements of 50%

• Initial Margin: You started with a $10,000 deposit and a 2% margin requirement, so your initial margin was $2,000 ($10,000 * 2%)
• Maintenance Margin: Let’s assume the maintenance margin is set at 50% of the initial margin, which is $2,000 ($2,000 * 50%)
• Equity Drop: Your equity has now fallen to $2,000 as the trade has gone against you by $8,000.
• Negative available margin: Since your account equity has fallen to the maintenance margin requirement level of $2,000, you’ve effectively used up all your available margin and you will be subject to a margin call.

This is the calculation to see how much margin is left as a percentage (it will be a negative value):

Calculation:

Available Margin % = (Current Equity – Maintenance Margin) / Initial Margin * 100%

Let’s build a calculator to do this – plugging in the numbers:

Available Margin % = $2,000 / $2,000 * 100% = 100%

The 100% indicates that your account equity has fallen to the point where you have no more usable margin.

This triggers a margin call, because you don’t have enough capital to cover the potential losses in your open position.

Since your equity has fallen to the maintenance margin requirement of $2,000, your broker will issue a margin call.

A margin call from your broker requires immediate attention.

Options if you receive a margin call

If you receive a margin call, you have a few options available:

• Deposit additional funds: You can add more money to your account to bring your equity back above the maintenance margin level
• Reduce your position size: You can partially close your position to free up some margin and increase your account equity
• Liquidation: If you don’t take any action, your broker will liquidate (sell) a portion or all of your position to meet the maintenance margin requirement.

If you take no action when you receive a margin call, some or all of your position will be liquidated, and you’ll have no choice about the point at which you exit your trade.

It will automatically be done for you, which could result in significant losses.

Using a forex margin calculator

A margin calculator streamlines the process of determining the margin requirement for a trade.

By entering details like your currency pair, trade size, and leverage, you can swiftly calculate the margin needed for a trade.

A margin calculator will help you work out your position size and understand the minimum margin you need to help you avoid margin calls.

Don’t feel pressured to use all leverage offered to you

Understanding margin requirements, and what leverage actually means, is vital for all new traders.

It’s vital to understand that while leveraging can amplify your trading opportunities, it also escalates the risk of large losses.

This is because you can end up losing more than the size of the original trade you entered.

For this reason, if you are a new trader, don’t feel pressured to use all the leverage offered to you.

It may be safer to just use a smaller amount of leverage when you first start trading, until you are experienced with risk management and setting automatic stop losses.

Think of it like a bank offering you a new credit card which has a credit limit of $5,000.

Just because you have a $5,000 credit limit doesn’t mean it’s sensible to immediately go out and spend $5,000 using your credit card!

It’s far more sensible to just use the ‘lending power’ you need at the time, to keep your risk to a minimum and reduce your financial exposure.

Till next time, happy trading!