What is margin in the financial world

In this article, you'll discover everything you need to know about margin trading.

I'll guide you through calculating the required margin and explain all the essential terms to help you understand margin trading.

Let's dive in!

What is margin

Only a small amount of trading capital is needed to open a trade in the Forex market.

This is known as margin!

For example, if you want to buy EUR/USD worth 100,000 currency units, you don't need to have 100,000 EUR in your account—depositing just 1,000 EUR could be enough.

Yes, with 1,000 EUR in equity, you can control a position worth 100,000 EUR in EUR/USD!

The exact margin required depends on your broker's terms and the leverage you use. Margin isn’t a fee or cost associated with the position.

In simple terms, margin is the minimum amount of money required to open and maintain a position.

Think of margin as the portion of your capital that your broker sets aside from your account balance to keep your positions open and to cover any potential losses.

How does this work?

This is exactly what you’ll learn in the following sections!

What is margin trading

The biggest advantage that the Forex market offers is margin trading, but many people misunderstand the meaning and idea of ​​margin!

First of all, I want to distinguish "margin trading" from the term "margin"!

In financial markets, "margin" refers to the collateral required to trade a particular asset, which is deposited with an investment intermediary.

The margin serves as a way to access borrowed funds from the investment intermediary, allowing you to trade at a value greater than your initial deposit.

If this definition is unclear, I will further explain margin trading later in the article.

In simple terms, margin lets you execute trades that are much larger than your account balance.

With a small amount of capital, you can take a significantly larger position in the foreign exchange market.

For instance, with 1,000 EUR in your account, you could buy or sell 100,000 units of EUR/USD.

Learn how to start trading in our complete guide for beginners.

In this scenario, even a small price change in the traded asset can result in significant profits if the market moves in your favor. However, many new traders experience the opposite outcome due to their lack of understanding of margin trading principles.

To fully grasp how a margin account operates, it's essential to familiarize yourself with key terms such as:

• Stop Out;
• Margin Call;
• Margin Level;
• Free Margin;
• Equity;
• Balance.

These terms broadly represent the key parameters of a margin account. A change in one parameter often affects the others.

Take a close look at the MetaTrader 4 trading platform image, and then read the accompanying explanation.

The image displays a buy trade on the EUR/USD currency pair with a volume of 1 Lot and leverage of 1:500 at a price of 1.1885. A single Lot represents 100,000 currency units.

The margin required for this transaction is 200 EUR.

This is five hundred times less than the position size.

So, 100,000 currency units divided by 500 equals the 200 EUR margin needed to open and maintain the position.

The image also shows the following parameters:

• Balance: The total amount in the account;
• Equity: The current value of the account;
• Margin: The amount required to maintain the open position;
• Free Margin: The difference between the used margin and Equity;
• Margin Level: The percentage of Equity compared to the used margin.

Next, we'll explore each of these terms in more detail.

What is Balance

The balance is the amount you initially deposited with the broker to open a live account. This represents the funds you have available for trading in the financial markets. For example, if you deposit $10,000 when opening the account, your account balance is $10,000.

Your balance can change in several situations:

• When a swap is charged or credited;
• When you deposit or withdraw funds;
• When you close a position, whether in profit or loss.

Regarding open positions, it's important to note that the balance remains unchanged until the trade is closed, regardless of whether it's a profit or loss.

What is Equity

Equity reflects the account balance adjusted by the current profit or loss from open positions.

This represents the real-time value of your account.

Since it’s an instantaneous measure, the value of Equity constantly fluctuates with changes in the price of the traded instrument.

If you have no open positions, Balance = Equity.

If you have active trades, their results are added to this current balance. For instance, if you have a $10,000 balance and an open buy position on EUR/USD with 1 lot, and the trade is currently up by 50 pips or $500, that profit is reflected in your Equity.

In this scenario, the parameters would be as follows:

• Balance: $10 000
• Equity: $10 500

If you have a buy position with 1 lot of EUR/USD and the price moves against you by 20 pips, resulting in a loss, the parameters would then be:

• Balance: $10 000
• Equity: $9 800

It’s important to remember that these are real-time figures, meaning the Equity value changes continuously as long as the position remains open.

To summarize the difference between Balance and Equity:

• Balance: The total amount in your account, reflecting all closed trades, whether profitable or not.
• Equity: The account balance adjusted for all open positions, reflecting their current profit or loss.

For instance, if your Balance is $10,000 but your Equity is $20,000, it indicates a successful trade. Conversely, if your Balance is $10,000 but your Equity is only $2,000, it means you only have $2,000 available and are nearing the Stop Out level, which could result in automatic position closures.

What Stop Out is and why it triggers position closures will be covered next. Before that, let’s explore the term margin requirement in more detail.

What is margin requirement

Margin is a percentage of the position value you want to open. The required margin can vary depending on the broker and the currency pair, so it’s important to review the broker's terms and conditions before depositing real funds into a Forex account.

Different brokers may have varying margin requirements, such as:

• 0.25%;
• 0.50%;
• 2.0%;
• 3.0%, etc.

This percentage is referred to as the margin requirement!

The margin requirement is determined by leverage.

Leverage represents the ratio between the trade value and your account deposit. For example, a leverage of 1:100 allows you to trade 100 times the amount of your deposit, meaning a 1:100 leverage corresponds to a 1% margin requirement.

You can learn more about leverage in the following article:

>> What is leverage in the financial markets

What is margin required

Margin is represented as a specific amount.

For example, in a GBP/USD trade, to trade 100,000 currency units without leverage, you would need to deposit the full position size of 100,000 GBP.

However, with a 3% margin requirement, you only need 3,000 GBP (required margin) to open and maintain a position of 100,000 currency units.

USD/CAD example

Suppose you deposit $1,000 into your account with a broker and want to buy 1 full lot of USD/CAD, with a margin requirement of 0.2%.

(1 full lot equals 100,000 currency units)

How much margin will you need to open and maintain the position?

Since the base currency in USD/CAD is the US dollar, the value of one full lot is $100,000. With a margin requirement of 0.2%, you would need $200 as the required margin.

NZD/USD example

Let's say you deposit $1,000 into your account with a broker and want to buy 1 full lot of NZD/USD, with a margin requirement of 0.5%.

(1 full lot equals 100,000 currency units)

How much margin will you need to open and maintain the position?

In this scenario, the base currency is NZD, so the value of 1 full lot is 100,000 NZD. With a margin requirement of 0.5%, you would need 500 NZD as the required margin.

To convert this to your account currency, you would multiply the required margin by the current NZD/USD exchange rate, which is 0.6965.

So, the required margin in USD would be:

500 * 0.6965 = $348.25 to open and maintain 1 lot of NZD/USD.

If this seems complex, remember that the trading platform automatically handles these calculations.

You don't need to perform any complicated math.

Additionally, we've developed an expert system to help you assess trade risks. The Trading Assistant EA will show you the exact trade volume and the amount you can afford to risk before closing a trade.

What is used margin

The used margin is the total of the required margins for all open positions.

If you have multiple trades open simultaneously, each one requires a specific amount that the broker "locks in" as the required margin.

Here's the difference between the required margin and the used margin:

• Required margin: The margin needed for each trade.
• Used margin: The total margin required for all open trades combined.

The example above illustrates a EUR/USD trade with a volume of 1 lot, requiring a margin of EUR 200.

In the next image, there are two EUR/USD trades, each with a volume of 1 lot. Each trade requires a margin of EUR 200, so the total margin for both trades is EUR 400, referred to as the used margin.

What is free margin

We've already discussed the used margin and equity.

Free margin is the difference between the two.

Free Margin = Equity - Used Margin

Using the same example with the two EUR/USD trades:

• Equity: 977.80 EUR;
• Used Margin: 400.00 EUR;
• Free Margin: 577.80 EUR.

Now, let's dive into what margin level is.

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What is a margin level

The margin level is the percentage ratio between your equity and the used margin.

• A higher margin level means you have more free margin available for new trades;
• A lower margin level indicates less free margin for additional trades.

Margin Level = (Equity / Used Margin) x 100

Let's calculate the margin level (ML) for an account with 900 EUR, which has three active EUR/USD trades, each with a volume of one lot. The total volume is three lots, the current balance is 857.92 EUR, and the used margin is 600 EUR.

Using the formula:

ML = (857.92 / 600) x 100

ML = 1.4299 x 100

ML = 142.99%

For an account with 900 EUR, trading three lots is too high a volume.

Even a slight unfavorable price movement could result in the closure of positions and a loss of funds.

This indicates that you have reached the Stop Out level.

Next, we'll delve into what a Stop Out is in margin trading.

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What is a Stop Out

A Stop Out is a level at which the broker automatically closes one or more of your open positions.

This happens when the margin level drops below a specified percentage, leaving insufficient free margin to maintain the positions. In other words, it occurs when the current balance falls below the used margin. The exact percentage for the Stop Out level is set by each broker.

When the Stop Out level is reached, the broker will start closing trades automatically, beginning with the position that has the largest loss. This process continues until the current balance exceeds the used margin, raising the margin level above the Stop Out threshold.

These measures are taken by the broker to prevent further losses for both the client and themselves.

Here is a visual representation of the explanation above.

The current balance is 734.81 EUR, while the margin required to maintain the positions is 760 EUR. This means the free margin is -25.19 EUR, as the balance is 25.19 EUR short.

The process of automatically closing losing trades is known as Stop Out.

However, before reaching the Stop Out level, you will first encounter a Margin Call.

What is a Margin Call

A Margin Call happens when the margin level falls below a specific threshold.

When this threshold is reached, the broker notifies you that your free funds are diminishing and that you might soon reach the Stop Out level.

A Margin Call is generally considered less severe than a Stop Out.

Typically, brokers set the Margin Call level at 100% of the margin level. In the past, brokers would actually call clients to inform them of the decrease in their funds.

Today, this warning is delivered via email or as a message on the trading platform. Additionally, account parameters are highlighted in red, as shown in the image below.

The color change signifies that the Margin Call level has been reached.

It's important to distinguish between a Margin Call and the Margin Call level:

• Margin Call: An event that occurs when the Margin Call level is reached.
• Margin Call Level: A threshold set by the broker, which triggers a Margin Call when reached.

If the Margin Call level is set at 100%, you won't be able to open a new trade if your margin level is at 96.69%, as illustrated in the image above.

To avoid reaching the Margin Call and Stop Out levels, learn how to calculate the required margin for your trades.

The formula for calculating the required margin

The margin amount (margin requirement) is calculated as a percentage of the position size (lot value).

The required margin is initially calculated in the base currency of the traded currency pair. If the base currency differs from your account currency, the resulting value is converted using the appropriate exchange rate, as demonstrated in the NZD/USD example.

Here’s how to calculate the required margin when the base currency is the same as your account currency:

margin required = margin requirement * lot value

If the base currency of the traded currency pair is different from your account currency, use this formula:

required margin = margin requirement * lot value * exchange rate of the base currency and your account currency

EUR/USD trading example:

• Account balance: $1,000;
• Trade size: 0.1 Lot (10,000 currency units);
• Margin requirement: 0.25%.

Using the formula:

0,25% * 10 000 * 1,1862 = 

(0,25/100 ) * 10 000 * 1,1862 =

0,0025 * 10 000 * 1,1862 = 29.655

Thus, $29.655 is the required margin to open and maintain a 0.1 lot EUR/USD position.

Summary

In margin trading, your trading capacity relies on the free margin available rather than your account balance.

• Margin Requirement: The margin required is expressed as a percentage of the position value (based on the lot size);
• Required Margin: The margin required is expressed as a monetary amount.

These two concepts often differ in terms of their value.