What Is Margin?
By: Lisa
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Everybody talks about Magin. But what is margin? I'm going to explain Margin, with regard to forex trading.
Margin is defined as security, as a percentage in money, deposited with a broker by a client as a provision against loss on transactions, or, the amount representing the customer's investment or equity in such an account.
The minimum security (margin) for each lot will vary from broker to broker. In the example above, the broker required a one percent margin. This means that for every $100,000 traded, the broker wants $1,000 as a deposit (or margin) on the position.
For example, for every $1,000 you have, you can trade 1 standard lot of $100,000. So if you have $5,000 they may allow you to trade up to $500,000 of Forex. Again, as you will see, this is probably a bad idea. You should never use your entire available margin during your trading.
So you open an account with $1000. You place a trade for 1 standard lot of $100,000, and using your 100:1 leverage your margin is $1,000. Now your available margin is $0. If your position moves against you by 1 pip, your available margin is negative, and the broker will most assuredly immediately close your position. Even if the price now suddenly moves with you by 100 pips, your trade is already closed out. You didn't leave any room for your trade to move. Of course, due to the spread, your broker wouldn't have even let you make this trade as your account balance would have been negative the instant you placed the order anyway.
The protection provided by the margin is evident in this example. While your available margin was 0, once your trade closed out, your used margin is returned to your account, less the trade losses. So in this example, you would have lost only $12 of your account value (don't forget the spread).
Let’s look at another example:
You open up a mini-account with $1000. This time, you decide to place an order for 2 mini lots (essentially 0.1 standard lot). The contract size is now $10,000, which means with your leveraging of 100:1, your margin requirement is only $100 per lot, so $200 total.
Now you have $200 used margin, and $800 available margin. Now your position has room to breathe. Let’s say, for example, that it moves against you by 10 pips. On a mini account like this, it would be a $10 move ($1 per pip). Your available margin is now $780, which is more than enough available that the broker won't close out your position. Now it moves in your favor by 70 pips and you decide to close the trade. The initial 10 pip loss doesn't even matter at this point, since your trade remained open, and instead of a loss, you now have a $70 profit (less the spread).
Can you see the power of leveraging and margin?
It's crucial to remember: increasing leverage increases risk. To limit downside risk, monitor your account regularly and use stop-loss orders on every open position. We will talk more about stop losses and other order methods a bit later. Just remember that leveraging can work for you, but it can also work against you.
Well, thats it for Margin. Keep learning and mastering forex right here at PipsAngels.com. Come back and see me soon!
