Contents
- General Concept of Margin
- How to Calculate Margin in the Forex Market
- CALCULATION EXAMPLE
- What Is Free Margin in the Forex Market
- Advantages and Mechanism of Margin Trading
- Definitions of the Terms "Leverage," "Trading Lot," and "Price Point"
General Concept of Margin
In the context of the forex market, the term "margin" is commonly used to refer to a certain amount of funds in a speculator's trading deposit that is held by a forex broker as security (collateral) each time leverage is provided to the speculator to execute a trade with a standard lot.
What is margin in the forex market? Margin is considered to be a certain portion of a forex speculator's trading capital that they must deposit into their trading account as a kind of collateral for the broker's credit received as part of forex trading. Without such broker credit, as is known, a "remote" private speculator will not be able to execute any currency trades in the forex market.
Any speculative online transaction with a currency contract necessarily involves two interdependent procedures:
- if "playing for a rise" – buying (buy) currency at the most favorable ASK rate (opening the trade), and then selling it (sell) at the most favorable BID rate (closing the trade);
- buying (buy) at the most favorable ASK rate (closing the trade).
Regardless of the direction of the "play" (for a rise or a fall), the price at which the trader sells the currency must be higher than the price at which the same currency is purchased (within one specific trade). If a trader uses high leverage, it is extremely important to be able to properly allocate funds in the account, and for this it is necessary to correctly calculate the margin amount. Many brokers' websites have margin calculators, but it is better to know how to calculate margin in the forex market and be able to do it independently.
How to Calculate Margin in the Forex Market
When calculating the margin amount, it is first necessary to take into account whether the trader has pending orders on the balance in the currency used in the trading process. To calculate margin in the forex market, you need to know the leverage, the current exchange rate of the currency pair, and the trade volume. The margin calculation formula is as follows:
Margin = Trade Volume/Leverage* Exchange Rate
It is important to note that when calculating using this formula, the volume must be specified not in lots, but in units.
CALCULATION EXAMPLE
You need to buy 0,5 lot of the EUR/USD currency pair with leverage of 1:500 and at a price of 1,24. In this case, the calculation formula will look as follows:
- Margin: 50000 / 500 х 1,24
- The collateral amount will be 124 USD
What Is Free Margin in the Forex Market
Free Margin - the difference between the margin of open positions and the amount of funds held in the trader's trading account.
If you know how to correctly determine the margin level in the forex market and compare its indicators with your capabilities, you can significantly increase your profit level. If these parameters are not compared, the speculator's risks will increase significantly, and the trader may lose money even if they correctly choose the direction of the price movement in a trade.
Advantages and Mechanism of Margin Trading
The use of margin trading mechanisms in the forex market makes it possible to significantly increase the volume of transactions in the forex market. Its essence is that exchange transactions are carried out through netting, without involving real funds.
The standard lot size is 100 000 units of the contract's base currency (for an EUR/USD contract, the base currency is EUR). There is also a mini-lot (0,1 of a standard lot) and a micro-lot (0,01 of a standard lot). Trade sizes may amount to several lots, and small and medium-sized speculators do not have such amounts at their disposal. This is why the margin trading mechanism began to be used; it started operating thanks to the intermediary activities of brokers, and this made it possible to sharply increase transaction volumes.
Definitions of the Terms "Leverage," "Trading Lot," and "Price Point"
The term "margin" in the forex market is quite closely linked to other equally important concepts of this market – "leverage," "trading lot," and "price point."
A price point is the minimum ("atomic") unit of exchange rate movement. The specific value of one "point" for a particular currency pair is directly determined by the characteristics of the currency pair itself. A trading lot is a quantitative characteristic of the volume of the asset being sold or purchased by the trader.
To be able to trade a standard lot, the trader is forced to use "broker credit," the possible ratio of which to the amount of trading account funds available to the trader is determined by the leverage, which is one of the main parameters in forex trading.
It should be noted that the amount of the aforementioned margin is inversely dependent on the size of the trading lot and the amount of leverage. The larger the trading lot and the leverage corresponding to the trade being executed, the smaller the margin amount the speculator will need for this trade.
