What is Margin?
So what about the term “margin”? Excellent question. Let’s go back to the earlier example: In forex, to control a $100,000 position, your broker will set aside $1,000 from your account. Your leverage, which is expressed in ratios, is now 100:1. You’re now controlling $100,000 with $1,000. The $1,000 deposit is the “margin” you had to give to use leverage.
Margin is the amount of money needed as a “good faith deposit” to open a position with your broker. It is used by your broker to maintain your position. Your broker takes your margin deposit and pools them with everyone else’s margin deposits, and uses this one “super margin deposit” to be able to place trades within the interbank network. Margin is usually expressed as a percentage of the full amount of the position. For example, most forex brokers say they require a 2%, 1%, .5% or .25% margin. Based on the margin required by your broker, you can calculate the maximum leverage you can wield with your trading account. There is much confusion about what these different “margins” mean so we will try our best to define each term:
- Margin requirement: This is an easy one because we just talked about it. It is the amount of money your broker requires you to open a position. It is expressed in percentages.
- Account balance: This is just another phrase for your trading bankroll. It’s the total amount of money you have in your trading account.
- Used margin: The amount of money that your broker has “locked up” to keep your current positions open. While this money is still yours, you can’t touch it until your broker gives it back to you either when you close your current positions or when you receive a margin call.
- Usable margin: This is the money in your account that is available to open new positions.
- Margin call: You get this when the amount of money in your account cannot cover your possible loss. It happens when your equity falls below your used margin. If a margin call occurs, some or all open positions will be closed by the broker at the market price.
Margin can be thought of as a good faith deposit or collateral that’s needed to open a position and keep it open. Margin trading gives you the ability to enter into positions larger than your account balance. Although buying and selling on margin does not provide leverage in and of itself, it can be used as a form of leverage. This is because the amount of margin you are allowed to take out typically depends on how much money you have in your account. Trading currencies on margin lets you increase your buying (and selling) power.