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Forex Market Structure, Forex Players and Forex History

Why Trade Forex? Advantages of Forex Trading, Forex vs. Stocks vs. Futures

What is Margin Trading, Used Margin, Free Margin, Balance, Equity, Margin Call Level and Stop Out Level?

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What is Margin Trading, Used Margin, Free Margin, Balance, Equity, Margin Call Level and Stop Out Level?
What is Margin Trading, Used Margin, Free Margin, Balance, Equity, Margin Call Level and Stop Out Level?
Trading using margin is one of the main reasons why people choose to trade in forex instead of the options available. Margin trading is trading with just a fraction of the sum of what the total deal costs. Many traders are clueless about what margin trading is and thus end up either not using it all or lose money because of use in spite of improper knowledge. Margin trading allows you to trade for capitals much more than what your balance is. With a little bit of balance, you can open much bigger trades in the forex market. This way, when the trade moves even slightly in your favor, you can sell the trade and thus earn a much larger profit than what you would have got as returns on the trade with your capital. You need to be very careful when trading with margins as that could lead to enormous losses as well if the market moves against you. In margin trading, there are a number of jargons which can confuse you and hence it is necessary to study them properly before starting with margin trading. Margin trading can earn you massive profits if you use it to your profit. You need to consider a number of metrics while margin trading to see if things are turning south and close the deal as soon as possible. Margin trading is one of the most effective ways to trade in the forex market with risk lesser than usual, but you need to consider multiple factors before you start to avoid causing losses.
What is Margin?
Margin is something that you must have heard all the traders talk about all the time. Margin is money in terms of trading forex. When you open a new account and want to start trading in forex, you need to put up only a small part of the capital that you want to trade. This capital is known as the margin. This margin is required for both, to open a position as well as maintain it. For example, you want to buy $1000 of USD/CHF; you need not put up the entire capital. You need to deposit a certain amount of what the trade is worth which might be around $300400. The amount depends on the rates that your CFD provider or forex broker has decided. In simpler terms, margin can be considered as a token of goodwill or collateral that you require to open a new position and keep it open for as long as you need it. What is essential to understand is that margin is not a transaction fee or cost that you render but merely collateral. Margin merely is an amount that you have pledged for a trade and the amount that your trader keeps aside from the balance with him to ensure that the trade is open and in case of loss, he can cover the cost of the trade. This margin is locked up for the duration of the trade and thus cannot be used to open new positions.
What is Used Margin?
In the market, every time you open a new position, you need to set aside a required margin which is equivalent to the position at which you are opening. This margin is known as the required margin. If you open multiple positions at different times, there will be multiple individual required margins. Now that you have multiple openings, you have multiple required margins as well. Upon adding all of these required margins, you get your used margin. This total amount is always larger than or equal to the required margin depending upon how many positions you have. This used margin is locked up against your positions for which you have pledged them and hence cannot be used to open new positions. Since this margin is used during the previous opening positions, it is called as the used margin. This used margin the amount that you need to deposit in order to ensure that all your trades are open. In case that your used margin is not maintained/ deposited, it can affect your trades.
Example:
Let’s consider that you have $1000 in your account and decide to open three new openings.
 Long USD/JPY – 1 mini lot position
 Long USD/CHF – 1 mini lot position
 Long USD/INR – 1 mini lot position
Now consider that the margin requirement for each of these is 2%, 2%, and 3% respectively. Since the base for the trade is USD, each of the lots has a notional value of $10000 which totals to $30000.
Now the required margin for each of the lots will be $200, $200 and $300 respectively. The used margin for all of these trades is the cumulative of the required margins. Hence, the used margin in this trade is $700.
What is Free Margin?
There are two types of Margin, “used” and “free.”
Used Margin is the cumulative amount of all the Required Margin. (All open Trades)
Free Margin= Difference between Used Margin and Equity. Usable Margin and Free Margin is synonymous.
Free Margin is of two kinds:
 Usable Margin to open a new trade.
 The amount of existing trade can move against the trader before a Stop Out.
Calculation of Free Margin:
Free Margin= Equity – Used Margin
With the increasing equity of presently profitable open trade, the Free Margin will also be increasing and will be decreasing while losing money and falling equity.
Situation1: No open Position
No open position is there.
So, what about free Margin?
First, calculate Equity:
Equity= Account Balance + Floating Amount (P/L)
$1000=$1000+$0
Now, let’s see the Free Margin:
Free Margin= Equity – Used Margin
$1000=$1000+$0
So, there is no Usable or Free Margin.
Situation 2: Open Long USD/JPY Trade
Trade Account Balance: $1000
Calculation of Required Margin
Condition: Long USD/JPY and about to open 1 mini lot trade (1000 units)
Needed Margin will be 4%.
He base currency: USD
And the lot needs 10,000 dollars.
So the Notional Value = $1000.
Required= Notional Value X Margin Requirement
$400= $10,000 X $0.04
Calculation of Used Margin
There is a single open Trade.
So, Free Margin= Required Margin
Calculation of Equity
Suppose, the price is in favor. The floating P/L is $0.
Equity= Account Balance + Floating Amount (P/L)
$1000=$1000+$0
Free Margin= Equity – Used Margin
$600= $1000 – $400.
So, the Equity is equal to the sum of Used and Free Margin.
What is Margin Level?
The Margin Level helps to guide you about the available funds for the new trade. This nothing but is the proportion (%) value dependent on the measure of Equity against Used Margin. The Free Margin depends on the ups and downs of Margin level.
The way of Calculating Margin Level:
Margin Level is (Equity / Used Margin) multiplied by 100%
The margin level will be instantly calculated by Trading Platform.
If you do not have any open trade, then margin will be “0”
Margin level determines whether one can open additional positions in Forex. Margin Level Limits vary from broker to broker.
Precedent #1: Opening a long USD/JPY position
You have 1 mini lot (10,000 units)
Assume, you also have a $1,000 as account balance
Stage 1: Calculating Required Margin
You need 4% Margin to go long USD/JPY to open 1 mini lot.
What amount of margin (Required Margin) is required to open the position?
The base currency is USD and mini lot is 10,000 dollars, so position’s Notional Value is $10,000
Required Margin = Notional Value x Margin Requirement
$400 = $10,000 x .04
Needed Margin will be $400.
Stage 2: Calculating Used Margin
Besides the trade we just entered, there aren’t some other exchanges open.
As we have a solitary position open, the Used Margin will be equivalent to Required Margin.
Stage 3: Calculating the Equity:
This implies your Floating P/L is $0.
Equity = Floating Profits (or Losses)+ Account Balance
$1,000 = $1,000 + $0
Now $1,000 is your equity.
Stage 4: Calculating Margin Level
Margin Level = (Equity / Used Margin) x 100%
250% = ($1,000 / $400) x 100%
So to recap, Margin level is the ratio between Used Margin and Equity.
What is Balance?
For you to be able to start trading in forex, it is mandatory for you to open an account with a CFD provider or a retail forex broker. This account is then approved by the broker after considering your documents after which, you can transfer funds to this account from your regular account. This new account is generally termed as a risk capital account since you should only transfer funds to this account which you can afford to lose. The funds that you move to this account and which you can use for further trading and opening new positions is known as balance. In simpler words, the balance of the account is the cash that you can use for trading from this account.
Thus, Balance = Cash
For example, if you deposit $1000 to your account, considering that your previous balance was nil, your current balance in this account will be $1000. As you go on opening trades and closing them, your balance in the account increases or decreases depending upon whether you make profits on those trades or not. The balance in your account is not affected until you close a position after opening it.
The only ways that the balance in your account can change are:
 In case you close a trade or a position.
 In case you keep trade open longer than the duration wherein you might be charged a rollover or swap fee.
 In case you deposit more money into the account.
Thus, the amount remaining in your account after the trade is known as the balance.
What is Equity?
Equity is nothing but the current value of the trading account and keeps fluctuating. Equity is the accumulation of account balance all the floating status of the open trades. With the ups and downs of current trades, the equity rises and falls.
The Calculation of Equity
Equity will be equivalent to Balance if there is no open trade.
Situation 1: When there is no Open Trade
Trading Account Deposit= $1000
No open trade means,
Balance=Equity=$1000
Situation 2: Where there are pen trades
Here Equity= Account Balance +Floating Profits (profit/loss)
Situation 3: When Trade is facing lose
The trading Account balance= $1000
Suppose you followed a tweet of a celebrity and go short, and face a floating loss 0f $50.
Now,
Equity= Trade Account Balance+ Floating Profit (or Loss)
$950= $1000 + ($50)
So, the Equity is $950
Now again you followed the same celeb and blindly obeyed his her decision and go long GBD/USD and eventually the profit is $100.
So, the Equity is $1100
Because, $1100= $1000+ $100 (floating profit).
If you have any open trade, then the equity is bound to alter with the changing market price. Equity is the momentary value of the account.
Equity and Balance: The Difference
As we have discussed before, if there is no position open, then Equity and balance will be the same.
In case of open trades:
Balance= profit/Loss (Closed Position)
Equity= Realtime status of Profit/Loss (both open and closed position).
Let’s say, the balance is $1000, and there is open trade, and the floating loss is $900. So the Equity will be $100.
So we guess, now you have a clear understanding of equity.
What is Unrealized P/L and Floating P/L?
P/L in the simplest form is profit and loss when it comes to money matters. It is the same case when you are trading forex. These P/L are often in green or red depending on your position which can be seen on the trading platform. If it is in green, it means that you have a profit whereas the red means that you are suffering from a loss. There are two types of profit and loss namely unrealized and floating.
Unrealized P/L or Floating P/L
The unrealized P/L is the profit or loss that all your open trades contain at that specific moment. In case you decide to close your trades at that very moment, this amount is the profit or loss that you will incur. These amounts change by the second every time the market refreshes or a deal is made on the commodity. This value constantly changes as long as you own the trade and it is open. This unrealized P/L and floating P/L are the same things.
Since this value keeps fluctuating all the time, in case the trade goes against you, a high amount of unrealized profit could quickly turn into an unrealized loss. As soon as the trade is closed, your unrealized P/L will turn into a realized P/L which will now not change at any cost unless you open the trade again. When the value of the trade goes below the value at which you bought it, you are incurring an unrealized loss which can turn into an unrealized profit as soon as the value goes above your buying value.
What is a Margin Call Level?
When Margin Level reach a certain threshold that’s call Margin Call Level, reaching that point means you can be forced to close your that particular open trade.
If, Margin Level=metric
Then, Margin Call Level= Value (of that metric)
Suppose, a forex broker’s Margin Call level is 100%.
So if the Margin Level falls to 100%, then there will be ‘Margin Call.’
Margin Call
If you are being notified about the fall of Margin Level lower than the requirement, that notification
is Margin all.
So, when
Floating Losses > Used Margin = Margin Call occurs
Margin Call and Margin Call Level Difference
Margin Call level is the sure point bet by the broker to generates a ‘Margin Call’.
Margin Call is an occurrence. And that leads to specific actions taken by the broker.
Let us understand the situation from the example of boiling water.
Water starts billing at 100° C.
Take Margin Level as Temperature. So, it can be 0° C, 71° C or 110° C.
But the Margin Call Level is 100° C, a certain temperature.
The Margin call is like water boiling, an occurrence when water will turn into vapor.
Situation 1: Margin Call Level 100%
In this situation, you will get alert when Margin Level Reaches 100%.
Margin Call Level = Margin Level @100%
If you reach this level, you can not open any new trade, but you close existing ones.
In this situation, Equity is equivalent to or lesser than the Used Margin.
Suppose,
Account Balance= $1000
You open one mini lot or 10,000 units with $200 Required Margin. The used Margin will be the same
because you have only one open trade. So, naturally, you will be stuck and lose big time.
Now, you fall 800 pips. And the floating loss is$800.
Equity= $200
Equity = Balance + Floating P/L
$200 = $1000 – $800
Margin Level = (Equity / Used Margin) x 100%
100% = ($200 / $200) x 100%
Stop Out Level is another crucial and specific level in trading.
If, Margin Call Level= water boiling.
Then, Stop Out Level= Being Burnt in that boiling water.
We will discuss Stop Out Level in Future.
What is a Stop Out Level?
Stop Out Level is something similar but worse than Margin Call Level. When the Margin Call Level falls to a certain percentage Level and all the open positions instantly close, then that certain
percentage level is Stop Out Level. The reason behind this liquidation is the lack of remaining margin. In other words, when the Equity level is lower than a particular portion of used Margin, then it’s Stop out Level. In such situations, closing open trades is a better option to avoid further losses.
This closing is actually known as ‘Stop Out’. Situation: Stop out Level 20%
Suppose the forex broker’s Stop out level is 20%.
So the accounts will be closed as soon as the Margin level touches 20%.
Stop Out Level = Margin Level @ 20%
You have already crossed the Margin, and the market is continually falling.
Assume, it now falls 960 pips.
Floating Loss= $960. ( $1/pip)
Equity= $40
Equity = Balance + Floating P/L
$40 = $1000 – $960
Margin Level= 20%
Margin Level = (Equity / Used Margin) x 100%
20% = ($40 / $200) x 100%
Now your positions will automatically liquidate or closed and your used Margin will turn into Free
Margin instantly.
So, your New balance Equity= Free Margin = $40 ( Floating Loss $960).
The Stop Out level prevents losing more than the deposited amount and future possibility of having
Negative Account Balance. This actually ‘STOP’ further loss.
Trading Scenario: Margin Call Level at 100% and No Separate Stop Out Level
So far you have learned different aspects of margin, trading situation and now we are about to discuss the situation when Margin Call Level is 100% and there is no distinct Stop Out Level.
Let’s check the reallife facts of the situations when trading can go wrong:
Stage 1: Fund Depositing to Trading Account
Trade Account Balance= $1000
Stage 2: Calculation of Required Margin
For long EUR/USED at 1.15000 and to open 10, 000 units 1 mini lot, the required Margin is 2%.
Base Currency= EUR
Mini lot= 10,000 euros=Notional Value
Trading account base currency= USD
So, $1.15 = €1
$11,500 = €10,000 = Notional Value
Required Margin = Notional Value x Margin Requirement
$230 = $11,500 x .02
Margin Requirement =2%, the
So, Required Margin = $230.
Stage 3: Calculation of Used Margin
Used Margin = Required Margin. (only one position is open)
Stage 4: Calculation of Equity
Suppose the price is slightly in favour of the trader and the position is trading at breakeven. So the floating P/L is $0.
So, Equity = Balance + Floating (P/L)
$1,000 = $1,000 + $0
Equity= $1,000.
Stage 5: Calculation of Free Margin
With the Equity, we can calculate the Free Margin:
Free Margin = Equity – Used Margin
$770 = $1,000 – $230
Free Margin= $770.
Stage 6: Calculation of Margin Level
We already know the equity and Used Margin
Margin Level = (Equity / Used Margin) x 100%
435% = ($1,000 / $230) x 100%
Margin Level = 435%.
EUR/USD falls 500 pips and presently trading at 1.10000
This is how your account will be affected:
EUR/USD drops 288 pips again
Required Margin= Notional Value X Margin Required
$214 = $10,712 x .02
( Notional Value = $1.07120 = €1. So, $10,712 = €10,000)
We have explained that previously, the Required Margin was $220.
Floating Loss = $788.
Your Equity = $212.
Used Margin= $214
So, Margin Level has reduced to 99%
Margin Level = (Equity / Used Margin) x 100%
99% = ($212 / $214) x 100%
Now it’s below the Margin Call Out
Your trading platform will instantly close your trade!
Trading Scenario: Margin Call Level at 100% and Stop Out Level at 50%
If you are a forex trader, you have multiple options of strategies to choose from. You can either operate with only margin calls, or you can opt to separately define the margin call and stop out
levels. This depends on the type of trader you are and what suits you individually. Here, in this chapter, we will understand the latter strategy when you are trading with an example. In this case, the broker defines the stop out level at 50% while the margin call is at 100%. First, you deposit $1000 in your account so your balance would be $1000. Now, you decide to go long on USD/CHF with a mini lot (10000 units) at the rate of 1.0000.
The margin requirement here is 5% which means that the required margin is $500 at a notional value of $10000. Since this is the only trade open, your used margin is $500, and the free margin is $500. Now, assume that the trade is at breakeven, which means that your floating P/L is $0. Since your equity is still $1000, the margin level turns out to be 200%. Now, assume that the trade falls 500 points to 0.9500. This makes your floating loss at $500.
After this fall, you required margin and notional value changes which means that the required margin would need to be calculated again. The notional value ends up being $9500. This means that your required margin is $475. This changes your equity, free margin as well as margin level. This takes your margin level below 100%. This means that you will receive a warning call and won't be able to open any new positions till it grows back to above 100%. Now, imagine that the trade takes a further hit, bringing the margin level below 50%, thus triggering the stop outcall. This leads to the termination of the deal immediately, and your loss is realized and the trade released. This will lead to a reduction in your balance.
Trading Scenario: What Happens If You Trade With Just $100?
Not everyone likes to start out big or can for that matter. Some traders begin their trading career with amounts as low as $100. We are here to understand if that is possible. Technically, no one can
stop you, but let's check the feasibility of it. Let's consider that the margin call level has been placed at 100% and the stop out at 20%. Now, the balance in your account is just $100. You decide to short the GBP/USD at 1.2000 and decide too open five micro lots (1000 units each) at a margin requirement of 1%.
The notional value of the trade is $6000. Thus, the required margin is $60. Since there is only one trade, the used margin is equal to the required margin. Consider that you are at break even and thus your floating P/L is $0 and the equity at $100. This puts your free margin at $40. By the formula, the margin level turns out to be 167% in this case. Let us consider that the trade now increases by 80 pips which brings down your margin level to 99% making the floating loss $40. Now the notional value of the trade has become $6040. This, in turn, affects the required margin, and it becomes $60.40. Since you have a floating loss of $40, your equity is reduced to $60. This renders your free margin to $0.
Since the margin is below 100%, you cannot open any new trades until it goes back above 100%. Now, the trade rises another 96 pips, which brings out the margin level to 20% where your stop out is triggered. This leaves your free margin at $12 since the used margin is released and the floating loss realized. This equity available is too less to trade. All of this loss occurred due to a movement in the trade by 176 pips which is very common to occur in a day or two and will lead to a total loss without being able to open a new trade.
The Relationship Between Margin and Leverage
Margin and leverage share a closeknit relationship as margin is used to create leverage. Leverage is actually the ‘trading power’ which allows you to trade positions larger than the amount in your trading account. Leverage is said to be the ratio between the amount of money you have and the amount of money you can trade. It can be expressed as “X:1”.
Suppose you wish to trade a standard lot of USD/JPY without margin, then you would need $100,000 in your account. But with a 1% margin, you just need to have $1000 in your account. The ratio, in this case, would be 100:1.
The following chart shows some margin requirements and their leverage ratios:
Currency Pair  Margin Required  Leverage Ratio 
EUR/USD  2%  50:1 
USD/JPY  4%  25:1 
EUR/AUD  3%  33:1 
Leverage can be calculated with the following formula:
Leverage = 1/ Margin Requirement
In order to calculate the margin requirement based on the leverage ratio, apply:
Margin Requirement = 1/ Leverage Ratio
Hence, it can be said that leverage is inversely related to the margin.
Both leverage and margin refer to similar concepts but from a different angle.
To explain it further, it can be looked at in this way:
When a trader sets up a position, he is required to fix a fraction of that position in good faith. Here, the trader can be considered as ‘leveraged’. However, the fraction which is reserved for good faith is what is known as ‘margin requirement’.
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