Assume you are a prosperous former British spy who now works in currency trading. A $10,000 deposit is made when you open a small account.
The $10,000 will be displayed in the “Equity” column of your “Account Information” box when you initially log in.
You will also see that the “Used Margin” is $0.00 and that the “Usable Margin” is $10,000, as pictured below:
Your Usable Margin will always be equal to the difference between “Equity” and “Used Margin.”
Equity – Used Margin = Usable Margin
As a result, the Equity, NOT the Balance, is used to calculate Usable Margin. Your equity will also decide whether or not a Margin Call is issued.
There will be no Margin Call as long as your Equity exceeds your Used Margin.
NO MARGIN CALL (Equity > Used Margin)
A margin call will be issued as soon as your Equity equals or falls below your Used Margin.
MARGIN CALL (Equity = Used Margin) = RETURN TO DEMO TRADING!
Assume you have a 1% margin requirement. You purchase one lot of EUR/USD.
Your equity is still $10,000. Because the margin required in a small account is $100 per lot, the used margin is now $100. The Usable Margin has increased to $9,900.
If you sold that one lot of EUR/USD at the same price at which you bought it, your Used Margin would return to $0.00 and your Usable Margin would return to $10,000. Your equity would remain constant at $10,000.
Instead of closing the 1 lot, you (the adrenaline-junkie, chop-socky individual that you are) became overconfident and purchased 79 more lots of EUR/USD for a total of 80 lots of EUR/USD because that’s just how you roll.
You will still have the same amount of equity, but your used margin will be $8,000 (80 lots at a margin of $100 per lot). And, as stated below, your Usable Margin is now only $2,000:
If the EUR/USD climbs while you are holding this highly hazardous position, you will make an absurdly large profit. However, this scenario does not end with a fairy tale.
Let us present a frightening picture of a Margin Call that occurs when the EUR/USD declines.
EUR/USD begins to decrease. Because you are long 80 lots, your equity will decline along with it.
Your Used Margin will remain at $8,000 for the time being.
When your equity falls below $8,000, you will be subject to a Margin Call.
This means that some or all of your 80 lot stake will be closed at the current market price right away.
Assuming you purchased all 80 lots at the same price, a Margin Call will occur if your trade moves 25 pips in your favor.
Humbug! That much movement in the EUR/USD in its sleep!
How did we arrive at 25 pips? Each pip in a mini lot is worth $1, and you have an open position with 80 frickin’ mini lots. So…
$1/pip multiplied by 80 lots equals $80/pip.
If the EUR/USD rises by one point, your equity rises by $80.
If the EUR/USD falls by one point, your equity falls by $80.
$2,000 Usable Margin divided by $80 per pip equals 25 pips.
Assume you purchased 80 lots of EUR/USD at $1.2000. If the EUR/USD falls to $1.1975, or -25 pips, your account will look like this.
Your Usable Margin is now $0.00, as you can see, and you will receive a MARGIN CALL!
Of course, you’re a seasoned international spy who has survived far worse disasters.
You have ice in your veins yet your heart rate is still 55 beats per minute.
This is how your account will appear after the margin call:
You lose $2,000 if the EUR/USD moves 25 PIPS, or less than.22% ((1.2000 – 1.1975) / 1.2000).
You squandered 20% of your trading account! ((($2,000 loss / $10,000 total))) X 100%
In actuality, EUR/USD can fluctuate 25 pips in a few seconds after a major economic data release, and certainly that much inside a trading day.
Oh, almost forgot…We didn’t even consider the SPREAD!
We didn’t even consider the spread to simplify the example, but we’ll now make it more realistic.
Assume the EUR/USD spread is 3 pips. This means that the EUR/USD only has to move 22 pips, not 25 pips, before triggering a margin call.
Consider losing $2,000 in 5 seconds.
This is what can happen if you don’t grasp margin dynamics and how to use leverage.
Unfortunately, most beginning traders do not even start a small account with $10,000.
You were able to withstand 25 pips before his margin call because you had at least $10,000.
If you only had $9,000 to begin with, you would have only been able to withstand a 10 pip decrease (with spread) before receiving a margin call. 10 pips!