Margin in Trading

Often times, beginner traders don’t know what the margin is. It may sound like a spy code, but it’s simple. 

Consider it the buying power your broker provides. So, you can trade more with less money. 

Let’s see what margin really is in trading:

What is the margin in trading?

Consider margin as a loan from your broker, allowing you to leverage your trading. When you open a margin account with your broker, they lend you funds to trade forex or any other financial instrument. 

When you enter a forex trade, your broker will specify an initial margin requirement for the currency pair you want to trade. This requirement is usually expressed as a percentage of the total trade size.

For example, if the broker sets an initial margin requirement of 2% and wants to trade $10,000 worth of currency, you must deposit $200 (2% of $10,000) as the initial margin in your trading account.

How did we get this value? 

Well, we got this due to a concept known as leverage. 

Leverage is like a magic wand that multiplies your trading power, while margin is the money you must set aside in your trading account to open and maintain a position.

Different brokers offer varying margin requirements, which, in turn, influence your leverage. Here’s a quick guide:

  • Margin Requirement: 5% → Leverage: 20:1
  • Margin Requirement: 3% → Leverage: 33:1
  • Margin Requirement: 2% → Leverage: 50:1
  • Margin Requirement: 1% → Leverage: 100:1
  • Margin Requirement: 0.5% → Leverage: 200:1

Keep in mind that margin requirements and leverage ratios can vary between brokers and the pair you are trading. 

Using the above, let’s say you’ve set aside $3,000 as your trading capital. If your broker offers you 30:1 leverage, this means you can control a trading position worth up to $90,000 ($3,000 x 30).

As you initiate and hold a forex trade, your account’s margin level will fluctuate based on unrealized profits or losses on your positions.

The margin level is calculated as (Equity / Used Margin) x 100. Equity represents the current account balance plus any unrealized profits or losses, while Used Margin is the amount of money tied up in your open positions.

This brings us to the margin call. 

Margin call 

A forex broker doesn’t allow you to trade on margin for fun. They do this as they want you to maintain a particular amount in your account to keep the position open. 

In the above, the broker will notify you that you need to maintain a $3000 balance to keep the entire trade open.

If your balance falls below $3000, you will be subject to a margin call. It is a request from the broker to deposit sufficient funds in the account to restore the amount to the original margin requirement of $3,000.

So, if the margin call hits, you lose the amount you traded with. 

Pros of margin in trading

  • Margin allows you to open larger positions than your account balance. 
  • You can amplify your returns. 
  • You can test short-term trading styles like scalping and day trading.

Cons of margin trading 

  • If the market moves against you, you can lose your capital. 
  • There is a chance of a margin call if the account balance falls below the initial one. 
  • It can affect a trader’s psychology as the stakes are high. 

Final thoughts 

So, there you have it! 

Margin trading is like riding a horse; it can be exciting, but you can fall from it without careful control. 

Before diving into margin trading, it’s essential to understand how it works, what is leverage, used margin, margin call, and the pros and cons. 

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