Margin and leverage
Leverage, Margin, Balance, Equity, Free Margin, Margin Call And Stop Out Level In Forex Trading.
Margin and leverage are two important terms that are usually hard for the forex traders to understand. It is very important to understand the meaning and the importance of a margin, the way it is calculated and the role leverage plays in a margin.
Leverage is a feature offered by a broker to help trade larger amounts by having a smaller account balance. For example, when your account leverage is 100:1, you can buy $100 by paying $1. Therefore, to buy $100,000 (one lot) you would only pay $1,000.
How much do you have to pay to buy 10 lots (USD) with an account that has a leverage of 50:1 ?
That is right, you would have to pay $20,000 to buy 10 lots or $1,000,000 USD.
$1,000,000 / 50 = $20,000
Leverage was so easy to understand, right? I had to explain that first, in order to explain the term "margin".
Margin is calculated based on the leverage, but to understand the margin lets forget about the leverage for now and assume that your account is not leveraged or indeed its leverage is 1:1.
Margin is the amount of money that is used in a position or a trade. Let’s say you have a $10,000 account and you want to buy €1,000 against USD. How many US dollars do you have to pay to buy €1,000?
EUR/USD rate is currently 1.4314. This means each Euro equals $1.4314.
Therefore, to buy €1,000 you have to pay $1,431.40
If you take a 1000 EUR/USD long position (you buy €1000 against USD), $1,431.4 from your $10,000 account has to participate in this position. When you set the volume to 0.01 lot (1000 unit) and then click on the buy button, $1,431.4 from your account will be paid to buy 1000 Euro against USD. This $1,431.4 is called margin. Now, if you close your EUR/USD position, this $1,431.40 will be released and will be back to your account balance.
Now let’s assume that your account has a 100:1 leverage. To buy 1000 Euro against USD, you have to pay 1/100 or 0.01 of the money that you had to pay when your account was not leveraged. Therefore, to buy 1000 Euro against USD, you have to pay $14.31. That number was calcuated as follows: $1,431.40 / 100 = $14.31.
Now, please tell me that if you take a one lot EUR/USD with an account with the leverage of 100:1, how much margin will participate in the trade?
One lot EUR/USD = 100,000 Euro against USD
EUR/USD rate: 1.4314
100,000 x 1.4314 = $143,140.00
One lot EUR =$143,140.00
Margin = $143,140.00 / 100 = $1,431.40
Therefore, to have a one lot EUR/USD position with a 100:1 account, $1,431.40 margin is needed.
You can use the below margin calculator to calculate the required margin in your trades:
When you have no open position, balance is the amount of the money you have in your account. For example, when you have a $5,000 account and you have no open position, your account balance is $5,000.
Equity is your account balance plus the floating profit/loss of your open positions.
When you have no open position and no floating profit/loss, then your account equity and balance are the same.
When you have some open positions - for example $1,500 in profit (in total), then your account equity is your account balance plus $1,500. If your positions were $1,500 in loss, then your account equity would be your account balance minus $1,500.
Free margin is the difference of your account equity and the open positions’ margin.
When you have no position, no money from your account is used as the margin. Therefore, all the money you have in your account is free. As long as you have no position, your account equity and free margin are the same as your account balance.
Let’s say you have a $10,000 account and you have some open positions with the total margin of $900 and your positions are $400 in profit.
Equity = $10,000 + $400 = $10,400
Free Margin = $10,400 – $900 = $9,500
Margin level is the ratio of equity to margin: Margin Level = (Equity / Margin) x 100.
Margin level is very important, brokers use it to determine whether or not the traders can take any new positions. Different brokers have different limits for the margin level, but this limit is usually 100% with most of the brokers. This limit is called Margin Call Level. A 100% margin call level means, if your account margin level reaches 100% you can still close your open positions but you cannot take any new positions. A 100% margin call level happens when your account equity equals the margin. It also happens when you have losing position/positions and the market keeps on going against you and your account equity equals the margin. At this point, you will not be able to take any new positions.
Let’s say you have a $10,000 account and you have a losing position with $1,000 margin. If your position goes against you and it goes to a -$9,000 loss, then the equity will be $1,000 ($10,000 – $9,000), which equals the margin. Therefore, the margin level will be 100%. If the margin level reaches 100%, you will not be able to take any new positions, unless the market turns around and your equity becomes greater than the margin.
But what if the market keeps on going against you?
If the market keeps on going against you, the broker will have to close your losing positions. Different brokers have different limits for this. This limit is called "stop out level", when the "stop out level" is set to 5% by a broker, the platform starts closing your losing positions automatically if your margin level reaches the 5%. It starts closing from the biggest losing position.
Usually, closing one losing position will take the margin level higher than 5%, because it will release the margin of that position, then the total used margin will go lower and the margin level will go higher. The system takes the margin level higher 5% by closing the biggest losing position first. However, if your other losing positions keep on losing and the margin level reaches 5% again, the system will close another losing position.
Why the broker closes your positions when the margin level reaches the stop out level?
The broker can not allow you to lose more than the money you have deposited in your account. The market can keep on going against you forever and the broker can not pay for this continuous loss.
How to check your account balance, equity, margin and margin level?
You can see this information by checking the MT4 terminal. Open the MT4 and press Ctrl+T. The terminal will be opened and it shows your account balance, equity, margin, free margin and margin level. Balance will change only when you close the position. The profit/loss will be added/deducted to the initial balance and the new balance will be displayed.
Balance – Floating Profit/Loss = Equity -- i.e. ($10,000 – $50 = $10,050)
Margin = $2,859.52 -- i.e. (200,000 x 1.4300) / 100 = $2,860.00
Equity – Margin = Free Margin -- i.e. ($10,050 – $2,859.52 = $7,190.48)
Equity / Margin x 100 = Margin Level -- i.e. ($10,050 / $2,859.52 x 100 = 351.46%)
You may need to read the above explanations for a few times to completely digest the terms I explained.
Briefly and in very simple words:
Leverage: Is the bonus you receive from the broker in order to to become able to trade large amounts with having a small amount of money in your account.
Margin: Is the money that will be placed and engaged in the positions that you take.
Balance: Is the total amount of the money you have in your account before taking any position. When you have an open position and its profit/loss goes up and down as the market moves, your account balance is still the same as it was before taking the position. If you close the position, the profit/loss of the position will be added/subtracted to your account balance and the new account balance will be displayed.
Equity: Equity is your account balance plus the floating profit/loss of your open positions. For example when you have an open position which is $500 in profit while your account balance is $5,000 then your account equity is $5,500. If you close this position the $500 profit will be added to your account balance and your account balance will become $5,500. If it was a losing position with -$500 loss, then while it was opened your account equity would be $4,500. If you close it, $500 will be deducted from your account balance and your account balance will now be $4,500. When you have no open positions your account equity will be the same as your account balance.
Free Margin: Free margin is the money that is not engaged in any trade, you can use it to take more positions. Free margin is the difference of the equity and margin. At the above example, your position margin is $10. Lets say the equity is $1,000 your free margin will be $990 ($1000 – $10). The greater your equity the greater your free margain.
Margin Level: Margin level is the ratio (%) of equity to margin. For example, when the equity is $1,000 and the margin is also $1,000 the margin level will be $1000 / $1000 = 1 or in fact 100%. If the equity was $2,000 then the margin level would be 200%.
Margin Call Level: If your margin level goes below this mark you will not be able to take any new positions. The margin call level is determined by the broker. When it is set to 100% you will not be able to take any new positions if your margin level reaches 100%. When you have losing positions your margin level goes down and becomes close to the margin call level. When you have winning positions, your margin level goes up.
Stop Out Level: If your margin level goes below it, the system starts closing your losing positions. It will close the biggest losing position first. If this helps the margin level go above the stop out level, no more position will be closed. If your other losing positions keep on losing and the margin level goes below the stop out level again, the system closes another losing position, the biggest one.