The money your broker requires you to have in your account to either open a new position or maintain an existing one is known as Forex Margin. The margin that is currently being used for an open position is known as ‘used margin’, whereas the balance left in your account is referred to as ‘free’ and can therefore be used to open a new trade if needed.
We know from the lesson on Forex leverage that your broker will be willing to loan you most of the funds necessary to open a position, but they will require you to put up a small amount of your own money. This is the margin amount.
Leveraged accounts have different Forex margin requirements, depending on the individual broker and what type of account you have. These requirements are expressed in ratios such as 100:1, 50:1 or 20:1.
A 100:1 margin account will allow you to trade $100 for every $1 you have available in margin. A 50:1 account lets you trade $50 per $1 in the account.
So, if you have a 100:1 account and you want to open a $200,000 position (two standard Forex lots), your margin requirement will be $2000, or 1% of the total position size.
Forex Margin Trading – Positives
The most obvious advantage of margin and one you will read about continuously as your learn to trade Forex, is the ability to achieve rapid gains by trading with amounts that you would not normally be able to. If, for example, you have a $1000 account which does not allow the use of margin, you can only open positions of up to $1000 in size. This would mean that each pip is worth only 10 cents to you. A trade which you close as a 50 pip winner would add $5 to your trading account. This is of course fine, but it would take you a long time to really build up your account balance.
On other hand, if your account containing $1000 was actually a relatively common 100:1 margin account, you are now able to open position sizes of up to $100,000. We know from the lesson on Forex pips that a $100,000 position will mean that each pip now equals $10 profit or loss. So a trade netting you 50 pips would add $500 to your account. This is the power of FX margin trading.
Forex Margin Trading – Negatives
We know that in currency trading margin can magnify your gains significantly. It can also however increase your losses in exactly the same way, something that is overlooked far too often by those new to Forex trading. If you do not use strict money management rules and calculate your position sizes correctly, trading FX on margin can be extremely risky.
Continuing with the example above, a $1000 account which uses no margin would see a $5 loss after a 50 pip losing trade, not even a small dent into our trading capital. Using the 100:1 margin account, the same trade would cost us $500, this is 50% of our balance. Even the best traders expect a few losers in a succession every now and then, so taking 50% losses is clearly unsustainable.
Forex Margin Calls
A margin call can take place when the account balance is reduced to an amount less than that required to maintain a trade which is currently open. This will be caused by a trade which is currently going against you and losing you money. At this point your broker may physically call you to make sure you are aware of the situation and let you know what options you have. You will either need to deposit further funds or close out the losing position.
It is quite common for a broker to close a trade automatically if you no longer have the necessary margin amount to support the open position. The point at which this happens will vary between brokers. For instance, some may close a trade when you have only half of the original margin required to open the trade, others may not let things go this far and will close the trade earlier.
In reality, you should never experience a margin call if you are following sound money management principles.
The bottom line is that Forex margin is a very powerful tool if you know how to use it effectively. Understanding effective risk management and the use of stop losses will allow you to take full advantage of margin accounts while minimizing your downside to only 1-2% of your account balance. It is highly recommended that as you continue to learn Forex trading, you take the time to become well versed in managing risk before you take live trades of any kind, no matter if your account allows margin or not.
Hopefully this has explained Foreign exchange margin accounts in enough detail for you to understand the subject. Use the comments section below to ask us anything you are not sure about.
If you have not already checked them out, for new traders we also recommend our beginners articles:
These should ease you into FX trading and get you used to how the markets work, as well as some of the terminology you will need to become familiar with.
