Understanding the Margin Requirement
The margin requirement for your open trades in the Forex market may seem confusing at first but it is essential to memorize the formula as it may serve you from falling into the horrendous margin call trap.
To simplify, the margin requirement is a certain portion of your account balance that is set aside to sustain your open trades in the market and is not a commission charged by your broker. Once you close your trades that funds that were allocated to sustain the open positions will return to the account balance.
We will begin with currency pairs that the US Dollar (USD) is the secondary currency such as EURUSD, AUDUSD, NZDUSD and GBPUSD. Before calculating the margin requirement it is important to make a note of the leverage that is provided by the forex broker. It may be as small as 25:1 or as high as 500:1. in our example, we will take a 200:1 leverage, which is supplied by most brokers for forex trading.
Let’s say you wish to open a trade of 1,000 units (0.01 lots in the MetaTrader4) in EURUSD, which is currently trading at 1.2750.
1,000 x 1.2750 = $1,275
if you buy 1,000 units in EURUSD, the margin requirement for the trade is $1,275. But, as the broker provides the ability to leverage, the required margin is reduced dramatically
$1,275 / 200 (the leverage) = $6.38
To summarize, executing a 1,000 units trade in EURUSD at 1.2750 will require $6.38 of your account balance to sustain the trade. When the trade is closed, the $6.38 will return to your account balance.
The above calculation is applicable also for GBPUSD, AUDUSD and NZDUSD as we have stated earlier.
In USDCAD, USDCHF and USDJPY the US Dollar acts as the base currency. In order to determine the margin requirement for those currency pairs the following calculation is made:
Trade size: 1,000 units
Available leverage: 200:1
Margin requirement = 1,000 / 200 = $5
Unlike EURUSD, we do not need USDCAD price in order to calculate the margin requirement, the trade size of the leverage are sufficient. The same calculation is applicable for USDCHF and USDJPY.
In this example we will show you how to calculate the margin when the US Dollar is not present in the base and secondary currency such as GBPJPY, EURGBP, NZDJPY etc. You may be surprised but the margin requirement will be determined by the base currency against the US Dollar regardless of the cross you wish trade.
To simplify, to calculate the margin requirement for GBPJPY we would use GBPUSD. To calculate the margin requirement for EURGBP we would use EURUSD.
GBPUSD price: 1.5640
Trade size: 1,000 units
Available leverage: 200:1
Margin requirement: As GBP is the base currency in GBPJPY, the margin requirement will be calculated using GBPUSD price.
1,000 (trade size) x 1.5640 (GBPUD price) = $1,564
$1,564 / 200 (the leverage) = $7.82
To summarize, $7.82 is the margin requirement for trading GBPJPY if the trade size is 1,000 units (0.01 lots in the MetaTrader4). In fact, this will be the margin requirement for all currency pairs where GBP acts as the base currency such as GBPCHF and GBPNZD.
We have focused on the minimal trade size that is accepted by most brokers. If you are trading in the MetaTrader4 (MT4) we strongly recommend you to memorize the value of lots in units as we specified in our forex trading guide.
To conclude the margin requirement, the bigger the leverage the broker is providing you the smaller the margin requirement would be regardless of the amount of leverage you chose to exercise. A broker that is offering 50:1 leverage will require $25.50 for the margin (assuming EURUSD price is 1.2750) while a broker that is offering 200:1 leverage will only require $6.38.
Balance, Equity, Free Margin and Margin Level
In many trading platforms you will see the following once you place trades in the market, Balance, Equity, Free Margin and Margin Level.
The balance would be the total amount of capital you have in your trading account excluding open trades. By open trades we mean profit/loss that are made on open positions in the market.
The equity is the total amount of capital you have in your balance including open trades.
The free margin is calculated by deducting the margin requirement for the open trade/s from the account balance.
The margin level is often displayed in percentage points. It is calculated by dividing the equity by the used margin and then multiplying it by 100.
Account balance: $10,000
Open trade/s size: 20,000 in EURUSD at 1.2750
EURUSD current price: 1.2760
Profit/Loss: +10 pips profit
The balance of the account would be $10,000 as the profit/loss of the open trade in EURUSD is not included in the balance until the trade is closed. The equity would be $10,000 +10 pips profit, which are worth $20. The equity would therefore reflect the $20 profit, which would be $10.020.
The margin requirement for a trade of 20,000 units (or 0.20 lots in the MT4) is $127.50 (we showed the margin calculation earlier). The free margin would be $10.020 (the equity) – $127.50 (margin requirement) = $9,892.50
The margin level would be $10,020 (equity) / $127.50 (total margin requirements) = 78.59
78.59 x 100 = 7,859%
As you may see you have plenty of margin available. However, when the margin level drops below 100% you are in a moderate risk of having all your trades closed automatically by the system. It will often occur if you decide to over-leverage your positions, which would boost the margin requirements for your trades.
Some brokers do notify their trades the margin level dips below 100%, which is commonly referred to as a margin call.
The Margin Call and Stop Out Level
A margin call will only occur when you have over-leveraged your trades, if you have decided to expose your entire investment into the market by not setting a stop loss order or a substantial stop that utilizes your entire account balance and the market trades against you to a point your margin level is below 100%.
When that occurs you will be able to close your trades but lack the ability to place new trades due to lack of free margin. If the market continues to trade against you, once the stop out level is reached all your positions will be instantly closed and a significant loss is likely to be incurred.
The stop out level is predetermined by you broker, it may be as small as 5.00% or as high as 50.00%. Regardless of whether you are considering to over-leverage or not it is essential to understand the trading conditions that are presented to you by the broker. Although the margin call is often made once the free margin dips below 100%, certain brokers may only initiate a margin call when the it reaches 70%.
You know understand what is the margin requirement, how to calculate the margin requirement, free margin, margin call and the stop out level as a result of insufficient margin.