Margin in forex trading refers to the amount of money you need in order to take out a trading position. It’s not a payment or cost for taking out the trade, but simply an amount of money you need to have in order to hold a trade. Let’s take a look.
Margin in forex trading explained
In order to explain what it is, first of all we need to take a quick look at a concept called leverage.
Leverage allows you to benefit from trading with much larger sums of money than you actually have in your account. This is what allows you to generate more profit.
However, this works in the other direction too. Just as leverage can magnify your gains, it will also magnify your losses.
Leverage is expressed as a ratio, such as 1:100. Let’s imagine a standard 1 lot trade of USDJPY, so $100,000 worth of Japanese Yen.
On a trading account with 1:100 leverage, this means that you only need to offer $1,000 in order to take this position. Your broker assigns you the remaining $99,000.
That $1,000 is the margin – the amount of money you need in order to hold this trade.
You can also express it as a percentage. The above trade requires just 1% of its value as margin. So on an account with 1:200 leverage, you’d only need a $500 to open the trade. As a percentage, that would be 0.5%.
Free margin
Margin alone is not enough to hold a position. A broker will typically require you to have a certain amount of money in your account, in addition to the funds used as the margin.
We call this amount free margin.
So for example, if the equity of your account is $10,000 and $1,000 is used as the margin for an open position, your free margin is $9,000.
That $9,000 can be used to open new trades, but most importantly, while you are a holding a position, its job is to absorb the costs of any trades that are running at a loss, should the price change against you.