Margin Trading in the Forex Market

Teaching Margin trading and its terms, reviewing the advantages and disadvantages of these trades and their connection with leverage in the forex market.

Margin trading in the forex market is one of the basic concepts every trader must comprehend. Trading in the forex market is done mostly through margin trading in brokers. Margin trading allows traders to control positions greater than their actual account balance. This article aims to provide a complete understanding of margin trading, explaining how it works and its associated benefits and risks. Stay tuned.

Contents

What is Margin Trading?

Margin trading is one of the key features of the forex market that allows traders to open positions greater than their account balance. This type of trading lets traders increase their potential profit but also increases the probability of loss.

Margin is the amount of money or security deposit that the broker receives from the trader to complete a trade, and after the end of the trade, this amount is returned to the trader's account. Every position opened in the market includes a certain amount of margin that the broker keeps until the end of the transaction. Note that the margin is not a payment or trade fee, but a guarantee received to open the transaction. For example, a trader with $1,000 in balance wants to buy EURUSD with a volume of 1 lot. The margin that the Trendo broker receives from the user with a leverage of 1000 for this transaction is $100. Note that this amount is not cut from the user's balance, and the user's balance is still $1000. But after opening the trade, the trader has $900 of free money for new trades, called free margin. $100 of the balance is involved in the EURUSD trade as margin, and cannot be withdrawn or used since the trade is open.

Read More: What is Lot in Forex?

What is the Required Margin?

The required Margin is the amount of money set aside and locked when opening a trade. That is what we call margin for short. The required margin can differ according to the traded currency pair, the trading volume, and the broker's regulations. Typically, major currency pairs such as EURUSD or GBPUSD require less margin. The reason for this is the liquidity and stability of the main currency pairs. Sometimes the required margin is stated as a percentage of the trade's total value. For example, if the required margin is 2%, a trader must deposit 2% of the total trade value as a margin. If a trader wants to open a position worth $100,000, he must deposit $2,000 as a margin.

What is Leverage's Role in Margin Trading?

In margin trading, leverage plays an important role. Leverage allows traders to open larger trades with less capital. Leverage is described in relative terms, such as 100:1 or 500:1. For example, with a leverage ratio of 100:1, a trader can open a trade worth $100,000 with only $1,000 of his capital. Leverage allows traders to potentially make significant profits, but also increases the risk of loss. Therefore, compliance with risk management is required when trading with high leverage.

Leverage is credit given by the broker to the trader so that he can make transactions with a higher volume and several times his balance. The higher the account leverage, the less margin is required for trading. For example, to buy 1 lot of USDJPY with 500 leverage, you need $200 of margin, and with 1000 leverage, you need $100 of margin.

Read More: What is a Forex Broker?

What is Free Margin?

Free margin is the amount with which traders can trade. The amount of money the broker receives as a security deposit and as a margin for opening a transaction is reduced from the free margin. For example, in Trendo Broker, for a trade with a volume of 1 lot in the USDJPY symbol, with an account whose leverage is 1000, we need $100 of free margin. Free margin is the amount of credit not involved in any trade.

Margin levels are determined directly by the broker. For example, the user's account balance is $1000, and he made trades that used $30 of margin, and the outcome of these trades after a few hours is $200 in loss. Therefore, the balance of the user's account is $800. We obtain the margin level (400%) by dividing the account balance by the margin.

When the margin level falls below a certain number (about 50-100%) due to losses, to open a new position, the trader will receive a margin call from the broker, which means that either additional funds should be deposited into the account or some open positions should be closed to open a new trade. When the market continues to move in the opposite direction of the trader's positions, and the margin level is reduced to a certain number, the broker will close the trades, and a stop-out will occur.

Read More: What is Margin Call and Stop Out in Forex?

An example of margin trading

Suppose a trader in Trendo Broker has a capital of $1000, and the account leverage is 1000. Therefore, the free margin of this account is $1000. The trader opens a gold Buy position in his account with a volume of 0.5 lots. As you can see in the picture, a $96 margin was used for this transaction. In other words, for the leverage of 1000 in Trendo Broker, a $1.92 margin is needed for every 0.01 lot of gold purchased.

Currently, the chosen transaction is in profit, the free margin of this account is $909.32. If the trader wants to calculate how many more lots he can buy in the gold symbol, it is enough to divide his free margin by the required margin for 0.01 lot of gold purchase. Therefore, the trader can trade another 4.73 lots in gold with this free margin. Note that the higher the account leverage, the less margin is required for trading.

In another example, suppose a trader in Trendo Broker has a capital of $1000 and this time, the account leverage is 100. The trader opens a gold buy position in his account with a volume of 0.5 lots. As you can see in the picture, a $962 margin was used for this transaction. In other words, in Trendo Broker, for leverage of 100, for every 0.01 lot of gold purchased, a $19.2 margin is needed.

Currently, the selected transaction is in profit, the free margin of this account is $65.98. If the trader wants to calculate how many more lots he can buy in the gold symbol, he only needs to divide his free margin by the required margin for 0.01 lot of gold purchase. Therefore, the trader can trade another 0.04 lots in gold with this free margin.

Margin Trading Advantages and disadvantages

Margin trading allows traders to open positions greater than their account balance, which means they can make more profit. In such a situation, even a small price movement can lead to significant profit in trading. Also, margin trading enables traders to diversify their portfolios by opening multiple trades in different symbols. This trading variety potentially increases the chance of profitability. On the other hand, margin trading is also high risk. These trades are like a double-edged sword that, if used well and professionally, can increase your profitability significantly, and if used without analysis and based on emotions, they have the potential to make your account zero.

Margin Trading Tips

Noting the following points is essential for those who intend to use margin trading.

Learn: Before using margin trading, learn its concept, risks, and benefits. Take advantage of the many available educational resources, such as online courses, books, and webinars.

Start with a small capital: Start with a demo or a real account with a small balance to gain practical experience without risking significant assets. That will allow you to accustom yourself to the platform, practice risk management, and develop your trading strategy.

Manage risk: Create and strictly stick to a risk and capital management plan. Set limits on the maximum leverage amount you are willing to use.

Monitor Margin Levels Regularly: Observe your margin levels to avoid margin calls and stop-outs. Regularly assess your trading account's health and adjust your positions accordingly.

Seek professional advice: Seek advice from experienced traders or help from a professional financial advisor. They can provide valuable insights and help you improve in the forex market.

Summary

Margin trading can be a powerful tool for forex traders that allows them to make huge profits. However, it is crucial to understand the complexities and risks of margin trading. These trades require a lot of training and practice. We recommend never risking more than two percent of your total capital per trade. There is no middle ground in the forex market, you will either succeed and achieve considerable wealth, or you will fail, so take the advice seriously.