Margin and margin requirements are something that no forex trader can afford to ignore. Margin has often been labeled a “good faith deposit” to open a position.
Margin is usually presented as a percentage amount of the full position, 0.25%, 0.5%, 1%, 2%, and so on. You can calculate the maximum leverage you can use with your trading account based on the margin required by your broker.
Why are margin calculations important？
Margin calculations in forex are a deposit that a trader puts up in order to secure a position. Think of it as collateral—it's not a fee or a cost, but it ensures that your account can handle whatever trades you are making. The margin that you have to put up entirely depends on the amount that you're trading. It's important not to put too much on margin because otherwise, you'll lose everything if your trades prove to be duds. Trading on margins is a big part of why stock dealers in the crash of 1929 lost so much. Make sure you keep that in mind while forex trading.
The formula for calculating the margin for a forex trade is simple. Just multiply the size of the trade by the margin percentage. Then, subtract the margin used for all trades from the remaining equity in your account. The resulting figure is the amount of margin that you have left.
How does a margin calculation work？
You might be staking a position for a currency pair, and neither the base nor the quote currency is the same as the currency used on your account. As a result, the margin requirement for these kinds of trades can be calculated in a currency that is different from what your own account deals with, which makes calculating margins a bit more difficult.
Let's say that you decided to trade with GBP and JPY. The currency you use in your account is USD. Suppose that you then decide to take a position with 10,000 units of currency. This means that you are buying 10,000 GBP against an equivalent number of JPY. You are paying in JPY and buying in GBP, but in reality, you are buying JPY with USD. As far as your broker is concerned, your margin requirement will be calculated solely in USD, or your main account currency.
Heres the formula required for calculating the margin requirement in your main account currency:
Margin Requirement = ([{Base Currency} ÷ {Account Currency}] ✕ Units) / Leverage
In the example of trading GBP/JPY, the terms in the above formula are as follows:
· Base Currency = GBP
· Account Currency = USD
· Quote Currency = JPY
· Base Currency/Account Currency = Current exchange rate of GBP/USD units = 10,000
· Base Currency/Account Currency = Exchange rate between the two traded currencies
For GBP/USD, this will, at the time of writing, be around 1.30.
Lets apply this calculation to another example using EUR/USD. Based on rates at the time of this writing, the current conversion price for this pair is 1.21773. If you were purchasing five standard lots—or 500,000 units—at the standard 30x margin, you would need $20,295.50 in your account to open this position.
While its important to learn how to do this math on your own, you can also use margin calculators to speed up these calculations and double-check your work.
What is margins impact on leverage？
Let us not forget leverage, which is also known as the “margin ratio.” This value can differ from one broker to the next, but generally, 30x the margin requirement can be considered typical. For the first example we outlined above, (1.3 ✕ 10,000) ÷ 30 = $433.33 USD.
In the third example outlined above, where a 20x margin was set, the increased ratio of leverage to investment reduced purchasing power and profit potential while still providing a profit opportunity that greatly exceeded what traditional trading could offer.
From this, it's pretty easy to determine how a change in any of the above values can impact your margin requirement. An increase in the leverage to 50x instead of 30x reduces the margin requirement to $260 USD. But this also means your potential losses relative to your current holdings increase by 67 percent.
It all sounds a little complex—and it can be—so remembering that margin and leverage are intertwined is crucial. The leverage requirement ultimately determines how much youre able to purchase as well as how much you need to keep in your account to make that position possible.
What is the relationship between leverage and margin requirement？
The lower margin requirement might seem more attractive because it lets you take the same position with fewer dollars. However, you want to be careful as a profitable trade means you'll earn more money, but a bad trade means your losses are amplified. Lower margins result in greater inherent risk. When traders fail to consider the implications of this margin trading opportunity, they could end up suffering significant losses before they realize whats happening to their account.
High leverage means your margin call won't come as quickly, but as a result, you'll lose more money. Higher leverage also reduces your profit potential, which may deter some traders who deem those proportions of risk and reward not worth pursuing through a margin order.
Knowing which values are most effective is all part of forex trading, and knowing the right values can only come with experience and time.
What are the risks and rewards of trading forex on margin？
Like any trading opportunity, margin trading offers its own unique set of risks and rewards—although the risks and rewards might be amplified through this trading strategy. Here is a look at some of the benefits and drawbacks to consider:
Rewards
1. Margin allows you to generate much larger profits than you could through your standard account balance.
2. You can grow your account value faster.
3. Margin trading may benefit experienced traders who can evaluate trades and make decisions quickly.
4. Less personal capital is committed to margin trading, allowing you to put those funds toward other investment opportunities.
Risks
1. Margin trading can be high-risk, exposing your account to significant losses based on the large trading volume.
2. Traders using margin may experience significant amounts of stress due to the implications of their trading.
3. You could be subject to a margin call and forced to either deposit more money to your account or to sell some of your holdings to free up capital as collateral for your open position.