One of the most distressing experiences a trader might face in forex trading is to receive a notification from a forex broker about a margin call. If a margin call is not managed correctly, it has the potential to leave a trader with considerable losses.
Therefore, understanding a forex margin call and how it occurs, is essential for successful and profitable forex trading and to avoid a lot of potential disappointment and financial setbacks as a forex trader.
However, to comprehend margin calls, it is absolutely necessary to firstly focus on the two interconnected concepts of margin and leverage.
Margin in forex
Margin is one of the most important concepts for a forex trader to comprehend before starting trading. Besides a so-called primary definition of “margin”, there are also other “margin” terms, such as used margin, required margin and free margin, to pay attention to.
Margin defined
Margin is the minimum amount of money required for a trader to open and maintain a new position. Put in other words, it is a percentage of the full amount of a position, set aside and assigned as a margin deposit, enabling you to keep your open positions with your forex broker. Normally, forex brokers will require anything from a low margin of 0.25% up to 2% or even higher.
The amount of margin required depends on the currency pair and discretion of the broker.
The percentage is referred to as the margin requirement.
Free margin
Free margin, also known as usable margin, refers to the amount of money that is not currently used in trading. It is the difference between your trading account equity and used margin and can be utilized to open new positions. If your open positions generate profits, the more your equity will increase, resulting in more free margin.
Required margin
Required margin refers to the amount of money that is put aside and “locked up” when a trading position is opened.
Regardless how many positions a trader opens, each specific position opened will have its own required margin.
Used margin
Is described as the total of all the required margin of all the open positions that is locked up, meaning they can not be used to open new positions.
Leverage in forex
Leverage in forex enables you to trade a substantial amount of money in the forex market with only a relatively small deposit and borrowing the rest from your broker. Leveraged trading is also referred to as margin trading.
Basically, margin and leverage are two sides of the same coin. Margin is indicated as a percentage, while leverage is expressed in ratios.
The margin required by your broker enables you to calculate the maximum leverage you are allowed to trade with.
For example: Your broker sets a 2% margin to control a R500 000 position. This implies that the broker puts R10 000 in your margin account, with which you are able to control currency to the sum of R500 000. The remaining R490 000 can be utilized as leverage. The 2% margin reflects a leverage of 50:1 (1/0.02 = 50). A 5% margin means a leverage of 20:1 (1/0.05 = 20), a 10% margin = 10:1 leverage, and so forth.
The average leverage in forex trading is normally very high – between 50:1 and 200:1. An account with a maximum leverage of 200:1 implies that even the slightest decrease in the value of your active trades can jeopardize your trading.
Although leverage allows forex traders to boost their profits, it also has the potential to increase losses. Leveraged trading is also considered a double-edge sword, because large price swings affect trading accounts with higher leverage, increasing the chances of triggering a stop-loss.
Margin level, margin call level and margin call explained
What is the meaning of margin level?
Margin level is the ratio of equity to used margin and is calculated as follows: Margin level = (equity/used margin) x 100.
Margin level is extremely important. It is an indication of the following:
- How much funds you have available to open new positions.
- The higher the margin level, the more free margin at your disposal to trade.
- The lower the margin level, the less free margin to trade with.
- You have no open positions if the margin level is zero.
Normally, trading platforms will automatically calculate and display margin levels.
What does margin call level mean?
A forex broker uses a specific margin level to determine whether a trader can open any new positions or not. This specific limit or threshold is known as a margin call level, which is a specific value of the margin level. The margin level set for a trader, differs between brokers, but most brokers set this level at 100%. Thus, the margin call level = Margin level @ 100%.
A 100% margin call level arises when your account equity equals or is lower than the used margin and you will not be able to open any new positions. You even face the risk of the possibility that some or all of your positions will be liquidated (forcibly closed). This usually occurs when you lose positions and the market is swiftly and continually turning against you.
Therefore, you will have to close existing positions if you want to open new positions.
The dreaded margin call
The term “margin call” originates from the days when brokers would call traders telephonically to inform them about their margin call levels. Nowadays, brokers normally no longer make margin phone calls – they use e-mails or text messages. It is also possible that a trader’s positions will automatically be closed without any forewarning.
Therefore, confirm with your broker if you will receive a margin call, or if your positions are automatically closed if you are unsuccessful to meet the acceptable margin level.
A margin call happens when the usable (free) margin falls below the acceptable margin level specified by the broker. Put differently, the trader no longer has any usable margin and the trading account needs more funding.
To meet a margin call you must either deposit additional funds or sell current positions. If you are unable to satisfy the margin call, your position or positions will be liquidated, and you stand a chance to suffer considerable losses.
Some suggestions how to prevent margin calls.
- Constantly monitor your trading account and keep it well funded.
- Diversify your positions.
- Avoid trading on margin in highly volatile currencies.
- Do not risk more than you can afford to lose.
- When trading, always consider your level of experience.
- Understand the extremely importance of margin and leverage.
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