Have you been wondering about what a margin means in forex? Relax as your everyday prayer request on knowing “what is margin in forex?” is about to be answered.
What is a margin? The English dictionary defines a margin as the yield or profit in a business. The selling price minus the cost of production.
In business, it is a collateral security deposit with a broker to compensate the broker in the event of a loss in speculative trading of commodities.
Hmmm! The “speculative trading of commodities” should ring something to your ears. Your prayer request is getting answered already, right?
Here is where I will leave you to keep assuming what a margin in forex means since you already know what a margin is according to the English dictionary.
Now, stop assuming, and let us explain what a margin in forex is.
What is Margin In Forex?.
Margin is the amount a trader needs to enter a position in the forex market. A broker determines what margin a trader uses in entering a trade.
It is usually given in percentage as it is a small portion of a trading capital that a broker sets aside for a trader to use in trading a currency pair.
A margin limits a trader’s loss and makes a trader’s potential profit unlimited. It helps to cover for loss in case a trade goes against his analysis.
In addition, the margin is related to other forex terms like equity, leverage, margin level, and free margin.
Here are some of their formula relations:
Free margin + Margin = Equity.
Margin level = Equity/ Margin × 100.
Margin × leverage = lot size.
Equity is the available amount in a trader’s account when a trade is going on.
Leverage is the money that a broker borrows a trader to increase his potential of making a profit.
Free margin is the funds available to trade.
Also, a margin is not an additional fee that a trader requires to trade but a portion of his trading capital that a broker sets aside as a form of “insurance” when a trade goes against the trader.
However, if a trader’s loss is setting close to his margin, his broker will notify him to fund his account.
If he fails to fund his account, the trade will automatically close once the loss reaches the margin. Traders refer to this notification as a Margin call.
How To Calculate a Margin.
Traders use various ways to calculate their margin. However, here is one of the simplest ways to do that:
Margin = Contract size × Price / Leverage.
Now, let us take an example;
Mr. Peter, an amateur trader, wants to buy 100,000 units of EUR in the EURUSD currency pair market which is at a current price of 1.25000.
If he decides to use a 50:1 leverage, how much margin does he require?
Applying the formula,
Margin = Contract size × Price / Leverage
Contract prize = 100,000
Price, which refers to the current market price = 1.2500
Leverage = 50:1
So, margin = 100,000 × 1.25000/50
Which gives 2500.
Margin = 2500
This means that he needs 2500USD to set the trade open.
Let us take another example;
What if Mr. John decides to make use of his margin level of 2% at a market price of 1.25250, what will be his margin using the same contract size?
Margin = Contract size × Current price × Margin level
100,000 × 1.25250 × 0.02
In this scenario, he needs 2505USD to set his position open.
Why a Margin is Important.
Margin helps a trader to secure their capital from excess losses.
It helps traders to trade bigger positions with their capital because with their leverages too, they get higher purchasing power.
Margin is a portion of a trader’s capital which a broker puts aside to enable him to trade a currency pair.
It relates directly to leverage. Leverage is the amount which a broker borrows a trader to increase his potential of making a profit.
Finally, do not forget that the forex market has rules that that guide it. One needs to have an in-depth knowledge of the financial market before he starts trading.
I hope this article answers your everyday prayer request of knowing what a margin is. Do not forget to keep visiting the websites to get more answers to your prayer requests.
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