What exactly is margin?
To start and maintain a fresh position in forex trading, you just need a little amount of funds.
This capital is referred to as the margin.
For example, if you want to buy $100,000 worth of USD/JPY, you only need to put up a percentage of that amount, such as $3,000. The exact amount is determined by your forex broker or CFD provider.
Margin can be conceived of as a good faith deposit or collateral required to initiate and maintain a trade.
It is a “good faith” promise that you can afford to keep the trade until it is closed.
Margin is NOT a fee or a cost of doing business.
Margin is just a fraction of your funds that your forex broker deducts from your account balance in order to keep your trade open and ensure that you can pay the trade’s possible loss.
This share is “locked up” or “utilized” for the term of the exchange.
When you close a transaction, the margin is “freed” or “released” back into your account and becomes “usable” again… to open new trades.
What is Margin Requirement?
Margin is expressed as a percentage (%) of the “full position size,” also known as the position’s “Notional Value.” The amount of margin required to open a trade VARIES depends on the currency pair and forex broker. Margin requirements may range from 0.25% to 0.5%, 1% to 2%, 5% to 10%, and even higher.
The Margin Requirement is this percentage (%). The following are some examples of margin needs for various currency pairs:
What is Required Margin?
The Required Margin is the amount of margin expressed as a precise amount of your account’s currency.
Each position you open has its own Required Margin amount that must be “locked up.”
Consider a typical EUR/USD (euro versus US currency) exchange. To purchase or sell 100,000 EUR/USD without leverage, the trader must put up $100,000 in account money, which is the whole value of the position.
However, with a Margin Requirement of 2%, the trader’s funds would only be required for $2,000 (the “Required Margin”) to initiate and hold that $100,000 EUR/USD position.
Required Margin is also known as Deposit Margin, Entry Margin, or Initial Margin.
Example #1: Open a long USD/JPY position.
Assume you have $1,000 in your account and wish to go long USD/JPY with a position size of 1 mini lot (10,000 units).
What margin will you require to open this position?
Because the USD is the foundation currency. This tiny lot is $10,000, hence the position’s Notional Value is $10,000.
Assuming your trading account is in USD, the Required Margin will be $400 because the Margin Requirement is 4%.
Example #2: Open a long GBP/USD position.
Assume you have $1,000 in your account and wish to go long GBP/USD at 1.30000 and open a position of 1 mini lot (10,000 units).
What margin will you require to open this position?
Because GBP is the base currency, this small lot is 10,000 pounds, resulting in a Notional Value of $13,000 for the position.
Assuming your trading account is denominated in USD, the Required Margin will be $650 because the Margin Requirement is 5%.
Example #3: Open a long EUR/AUD position.
Assume you wish to go long EUR/AUD and open a position of 1 mini lot (10,000 units).
What margin will you require to open this position?
Assuming your trading account is in USD, you must first understand the EUR/USD exchange rate. Assume the EUR/USD is trading at 1.15000.
Because EUR is the base currency, this mini lot is 10,000 euros, resulting in a Notional Value of $11,500 for the position.
Because the required margin is 3%, the required margin is $345.
How to Calculate Required Margin
The amount of margin (“Required Margin”) required to hold open a position while trading on margin is determined as a percentage (“Margin Requirement”) of the position size (“Notional Value”).
The Required Margin amount is computed based on the base currency of the currency pair transacted.
If the base currency is DIFFERENT from the currency of your trading account, the Required Margin is translated to your account denomination.
The following is the formula for calculating the Required Margin:
If the base currency is the SAME as the currency of your account:
If the base currency is DIFFERENT from the currency of your account:
The only reason you should have funds in your account is to ensure you have enough margin to trade with.
When it comes to forex trading, your capacity to open transactions is not always determined by the amount of money in your account. More precisely, it is determined by the amount of margin you have. This implies that your broker is always checking to see if you have enough margin in your account, which may or may not be the same as your account balance.
Don’t worry if this sounds confusing. As time goes on, it will become clearer.
Next Lesson: What is Used Margin?
