Home » Resources » What Is Margin In Forex?

What Is Margin In Forex?

Published by Jonathon Jachura

Reviewed by Bowen Khong, ACCA

Forex trading has many technical aspects that all traders should keep in mind. Margin is one of the most critical components. Usually expressed as a percentage, this piece of forex trading is a vital part of opening a trade. 

How Does Margin Fit Into Forex?

Margin refers to the quantity of money that needs to be put forward by a trader in order to open the trade. It is important to note that margin is not a transaction cost. Margin is essentially a portion of the total value of the trading position. 

You can express margin as a percentage of the total position amount. The total position amount is known as the Notional Value of the position you want to open. Requirements for margin vary, at times being as low as a quarter of a percent to upwards of ten percent.

While margin trading promotes a trader’s exposure to the market, it also increases potential profits and losses. Traders must monitor their margin levels to determine if they have enough funds in their forex account to open new positions or cover their potential losses for open trades. 

Margin Example

Investors have to deposit money into the margin account before the broker can place the trade. The deposit amount must meet the broker’s required margin percentage. Let’s say that an investor wants to trade $100,000. 

If the required margin were 1%, then this would mean that the investor needs to deposit $1,000 to open the trade. The broker would then provide the remaining 99% for the trade. 

Over weekends, brokers may require raised margins to hold the position due to an influx in liquidity risk, which essentially refers to the ease or efficiency with which security or assets can be transformed into ready cash, doing so without affecting its market price. 

While the margin might be 1% on weekdays, brokers may require 2% on weekends, bumping up the necessary margin to $2,000. Brokers use margins kind of like a security deposit. 

So, if the investor’s position is not doing well or worsens and losses are coming up on $1,000, then the broker may instate a margin call

Margin Level

Margin level is calculated as a percentage using your equity ratio to the used margin of your open positions. A healthy margin level should always be above 100%. 

The term “margin level” is an essential aspect of margin in forex trading. It essentially indicates the “health,” so to speak, of your trading account. 

The margin level formula looks like this: 

(Equity/Used Margin) x 100 = Margin Level

For example, let’s say you have an equity of $4,000, and you have used up $1,000 of margin. 

The formula would look like this: ($4,000/$1,000) x 100 = 400%. Since your margin level is at 400%, you have a healthy account.

If your margin level dips below 100%, you will have to either add funds to your account or close some of your positions to support your other positions. If it falls too low, you will likely receive a margin call from your broker. 

Leverage Versus Margin

Leveraged trading positions are where the trader uses a lesser amount of capital to boost exposure to more substantial trading positions. Leverage refers to the ratio that is applied to the margin to determine the size of the trade that is going to take place.

Leverage and margin are often confused, so it is essential to remember that margin is the amount of funding needed to open a trade. 

For example, let’s look at a leverage of 20:1. This essentially means that the trader can purchase $20,000 of foreign currencies for $1,000. The brokerage firm lends the trader the remaining cash. If the currency you invested in moves up 10%, you would have a $2,000 gain. 

However, if the currency moved down 10 percent, you would lose $2,000. Not only that, you would lose your entire investment of $1,000, and you would also need to pay off the loan to the brokerage firm.

What Is A Margin Call In Forex?

A margin call happens when margin levels drop of a trader’s positions into negative territory and the broker “calls” the trader to add more margin. When the margin level dips below 100 percent, the number of funds in the trader’s account can no longer cover margin requirements. 

In that case, brokers will typically ask that the trader’s equity be topped off (i.e., the trader must add more money to their account). 

During a margin call, the trader must either add more funds to meet the required margin or sell their assets to lower the margin required by the broker to maintain their account. 

What Is Equity?

Equity is the number of funds a trader has in their trading account, including their profit or loss from any of their open positions. Leverage, equity, and margins are three fundamental aspects of forex trading, all of which are intertwined. Equity is an essential part of successful trading. 

If the trader does not have any open positions, then the equity is equal to the trader’s balance. 

Equity and balance may appear as the same amount, and many traders new to the market confuse the two, but they refer to different amounts. 

What Is Forex?

The term “forex” is short for the foreign exchange market. It is a global market that runs 24 hours a day where traders can exchange national currencies. Forex trading is a massive liquid asset marketplace with a reach that extends worldwide. 

The foreign exchange market is a decentralized market that is not under the control of any singular entity. With that said, there are several large banks the frequently trade vast amounts of currencies. The most influential include JPMorgan, Citi, UBS, and Deutsche Bank. 

Exchanging currencies happen all the time. For example, if you wanted to purchase something from Egypt or any other foreign country with a different currency, you would have to exchange your currency for theirs. 

Currency exchange can happen directly, such as during traveling and through sales of goods and services. For example, if you buy something from a company selling foreign products on an e-commerce platform, a currency exchange occurs somewhere along the line. 

Whatever the method, currency exchange is a vital part of conducting business worldwide. 

You can consider currencies in forex as an asset class. Traders can earn the interest rate differential between two currencies, which is simply the difference in interest rates between two securities. 

They are also able to profit from changes in the exchange rate. These aspects of forex trading can make the exchange of currencies very lucrative but also risky. 

In fact, there are about $6.6 trillion traded on the foreign exchange market daily. The $1.1 trillion traded daily on the New York Stock Exchange pales in comparison.

Trading Example

Let’s say that the exchange rate between the euro and the United States dollar is 1.50 to 1. You decide to buy 1,000 euros at that rate, so you pay $1,500 U.S. dollars. 

Perhaps, later on, the currency rate moves to a rate of 1.60 to 1. Now, you could sell the euros you bought for $1,600, which would generate a profit of $100. 

The potential for investors to profit is there. However, investors must do so wisely as forex trading can be risky, especially when trading with leverage. 

Traders commonly trade several forex currency pairs. These pairs include:

  • Euro and U.S. dollar (EUR/USD)
  • U.S. dollar and Japanese yen (USD/JPY)
  • U.S. dollar and the British pound sterling (GBP/USD)
  • U.S. dollar and Swiss franc (USD/CHF)
  • Australian dollar and U.S. dollar (AUD/USD)
  • U.S. dollar and Canadian dollar (USD/CAD)
  • New Zealand dollar and U.S. dollar (NZD/USD)

These seven pairs compose three-quarters of all forex trades and are the most liquid and commonly traded pairs in the market. Many traders agree that these seven pairs are among the most profitable trading pairs. 

History

Forex trading has been around for centuries, initially starting around the time of the Babylonians. It was designed as a system to support currencies and exchange. 

Initially, people traded goods for other tangible items, like a loaf of bread for a goat or a piece of fruit for a pair of shoes. 

During the age of precious metals, gold and silver gained popularity, becoming the de facto currency for most of the world. 

Once the creation of coins came around, so did political regimes. Gold became more restricted since it was an important trading tool which caused the diminished value of currencies (until countries agreed on a gold standard). 

Eventually, the modern forex market was born. The foreign exchange market was introduced for monetary stability and reliability. In 1944, the initiative taken by the U.S dollar kicked off the world’s newest currency exchange. 

In those times, the IMF, GATT, and World Bank were formed and agreed upon by many nations at Bretton Woods. The agreement contained the Gold Standard, which equaled $35.00 per ounce of gold. This standard was fixed with other currencies to avoid furthering the instability of the monetary crisis. 

The modern form of the forex trading market started in the early 1970s. It was at this time that the U.S. allowed its currency to float in the forex market freely. 

Jonathon Jachura
Jonathon Jachura
You may also be interested in reading

Fact checked

ForexToStocks is committed to delivering content that adheres to the highest editorial standards in terms of accuracy, sourcing and objective analysis. 

Every article is written by topic experts with relevant academic credentials in the field of business, accounting and finance – including actual trading experience or someone who is a practitioner in the financial market. 

Before going live, each article is thoroughly reviewed and fact checked by a qualified member of the editorial team. 

Furthermore, we have a zero-tolerance policy regarding any level of plagiarism or malicious intent from our writers and contributors.

 
ForexToStocks articles adhere to the followings standards: 

  1. All referenced links must be from reputable websites and sources.
  2. All quotes, studies, data and significant claims must be referenced to its original sources.
  3. All commentary must maintain a high level of objectivity and provide balanced views.
  4. Content should avoid making claims or recommendations that would put readers financial well-being at risk. 
  5. Any potential conflict of interest must be clearly indicated and disclosed to readers. 

We are aware that our editorial process is not perfect, and we are constantly improving our editorial quality through readers feedback and internal review.  

Our #1 Top rated Forex Trading Platform

WORLD LEADER IN FINANCIAL TRADING SINCE 2010