What is Margin?
Margin trading in forex is trading with a loan borrowed (short-term loan) from a broker to control large positions on a currency pair.
A margin is the amount of money a broker will put aside to keep investor’s trading position(s) open.
However, it simply magnifies the amount of profit or loss on a trading account. The margin (loan) on a forex trading account is equivalent to the leverage of that account. The leverage on the margin account determines the margin level or percentage on the account.
Consequently, margin level reduces as more trader place more positions. As the positions traded closes into profit, the margin level increases (good for the trading account).
When the positions traded closes into a loss, the margin level decreases (account may soon get a margin call). Margin increases with increase in position traded (increase in lot size traded increases the margin).
Moreover, an investor that wants to trade up to $10,000 on a mini trading account (for example, with leverage ratio 100:1), he or she will require a 1% margin which is equivalent to $100 as the investment capital to be deposited to the trading account plus $9,900 as free margin from the broker.
The implication is, if a broker requires 1% margin (the trader will have a leverage ratio of 100:1) on a $100 deposit (which is the margin), the trader can trade up to $10,000 ($9,900 will be a free margin from the broker).
For instance, 1 lot of the currency pair traded will be $100 and if the trader opens several positions up to 50 lots, this means the trader is traded up to $5,000 (the remaining free margin will be $4,500).
If the broker requires 2% margin (the trader will have a leverage ratio of 50:1) on a $100 deposit (the margin), the trader can trade up to $5,000 ($4,900 will be a free margin from the broker).
Another instance is, if the broker requires 0.5% margin (the trader will have a leverage ratio of 200:1) on a $100 deposit (the margin), the trader can trade up to $20,000 ($19,900 will be a free margin from the broker).
Generally, if trade position worsens and the free margin drops from the initial $9,900 to $0 (the trading account is left with $100 margin which is equivalent to the initial deposit by the trader) the broker will initiate a margin call.
Basically, the trader is either advised to deposit more funds to the trading account or to close all the trading positions to limit risk. Failure to close all the open positions, some brokers will automatically close the positions to an acceptable limit while other will allow the trading account to run to zero balance.
As the account runs into losses, and equity falls below the margin, the trading account gets a margin call.
MT4 Terminal Margin formula
Margin + Free Margin = Equity
Equity/Margin x 100% = Margin Level
Margin call = Free margin drops to zero
Investing in a margin account comes with risk.