Leverage, Margin, Balance, Equity, Free Margin, Margin Call And Stop Out Level In Forex Trading

7 June 2015, 07:46
Abdul Salam
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Leverage, Margin, Balance, Equity, Free Margin, Margin Call And Stop Out Level In Forex Trading


I always see so many traders who trade forex, but still don’t know what margin, leverage, balance, equity, free margin and margin level are.

Margin and leverage are two important terms that are usually hard for the forex traders to understand. It is very important to understand the meaning and the importance of margin, the way they are calculated, and the role of leverage in margin.

Leverage:

Leverage is a feature offered by the broker, to help the traders to trade larger amounts of securities by having a smaller account balance. For example, when your account leverage is 100:1, you can buy $100 by paying $1. Therefore, to buy $100,000 (one lot), you should pay only $1000 (this is just an example. I know nobody pays dollar to buy dollar )

Now you tell me please. How much you have to pay to buy 10 lots USD with an account that its leverage is 50:1 ?

That is right. You have to pay $20,000 to buy 10 lots or $1,000,000 USD:

$1,000,000 / 50 = $20,000

Leverage was so easy to understand, right? I had to explain it first, to become able to talk about the other term which is margin.

Margin:

Margin is calculated based on the leverage, but to understand the margin, lets forget about the leverage for now and assume that your account is not leveraged or indeed its leverage is 1:1 

Margin is the amount of the money that participates in a position or trade. Let’s say you have a $10,000 account and you want to buy €1,000 against USD. How much US dollars do you have to pay to buy €1,000?

EUR/USD rate is currently 1.4314. It means each Euro equals $1.4314. Therefore, to buy €1,000, you have to pay $1,431.40:

€1,000 = 1000 x $1.4314

Therefore:

€1,000 = $1,431.4

If you take a 1000 EUR/USD long position (you buy €1000 against USD), $1,431.4 from your $10,000 account has to participate in this position. When you set the volume to 0.01 lot (1000 unit) and then you click on the buy button, $1,431.4 from your account will be paid to buy 1000 Euro against USD. This $1,431.4 is called margin. Now, if you close your EUR/USD position, this $1,431.4 will be released and will be back to your account balance.

Now let’s assume that your account has a 100:1 leverage. To buy 1000 Euro against USD, you have to pay 1/100 or 0.01 of the money that you had to pay when your account was not leveraged. Therefore, to buy 1000 Euro against USD, you have to pay $14.31:

$1,431.4 / 100 = $14.31

Now, please tell me that if you take a one lot EUR/USD with an account with the leverage of 100:1, how much margin will participate in the trade?

One lot EUR/USD = 100,000 Euro against USD
EUR/USD rate: 1.4314
100,000 x 1.4314 = 143,140.00
Therefore:
One lot EUR =$143,140.00

Leverage: 100:1

Margin = $143,140.00 / 100 = $1,431.40

Therefore, to have a one lot EUR/USD position with a 100:1 account, $1,431.40 margin is needed.

You can use the below margin calculator to calculate the required margin in your trades:

Balance:

When you have no open position, balance is the amount of the money you have in your account. For example, when you have a $5000 account and you have no open position, your account balance is $5000.

Equity:

Equity is your account balance plus the floating profit/loss of your open positions:

Equity = Balance + Floating Profit/Loss

When you have no open position, and so no floating profit/loss, then your account equity and balance are the same.

When you have some open positions and for example they are $1,500 in profit in total, then your account equity is your account balance plus $1,500. If your positions were $1,500 in loss, then your account equity would be your account balance minus $1,500.

Free Margin:

Free margin is the difference of your account equity and the open positions’ margin:

Free Margin = Equity – Margin

When you have no position, no money from your account is used as the margin. Therefore, all the money you have in your account is free. As long as you have no position, your account equity and free margin are the same as your account balance.

Let’s say you have a $10,000 account and you have some open positions with the total margin of $900 and your positions are $400 in profit. Therefore:

Equity = $10,000 + $400 = $10,400

Free Margin = $10,400 – $900 = $9,500

Margin Level:

Margin level is the ratio of equity to margin:

Margin Level = (Equity / Margin) x 100

Margin level is very important. Brokers use it to determine whether the traders can take any new positions or not. Different brokers have different limits for the margin level, but this limit is usually 100% with most of the brokers. This limit is called Margin Call Level. 100% margin call level means if your account margin level reaches 100%, you can still close your open positions, but you cannot take any new positions. Indeed, 100% margin call level happens when your account equity equals the margin. It happens when you have losing position/positions and the market keeps on going against you and when your account equity equals the margin, you will not be able to take any new positions anymore.

Let’s say you have a $10,000 account and you have a losing position with $1000 margin. If your position goes against you and it goes to a -$9000 loss, then the equity will be $1000 ($10,000 – $9,000), which equals the margin. Therefore, the margin level will be 100%. If the margin level reaches 100%, you will not be able to take any new positions, unless the market turns around and your equity becomes greater than the margin.

But what if the market keeps on going against you?

If the market keeps on going against you, the broker will have to close your losing positions. Different brokers have different limits for this too. This limit is called Stop Out Level. For example, when the stop out level is set to 5% by a broker, the platform starts closing your losing positions automatically if your margin level reaches 5%. It starts closing from the biggest losing position.

Usually, closing one losing position will take the margin level higher than 5%, because it will release the margin of that position, and so the total used margin will go lower and therefore the margin level will go higher. The system takes the margin level higher than 5% by closing the biggest losing position first. However, if your other losing positions keep on losing and the margin level reaches 5% again, the system will close another losing position.

Why the broker closes your positions when the margin level reaches the Stop Out Level?

The reason is that the broker can not allow you to lose more than the money you have deposited in your account. The market can keep on going against you forever and the broker can not pay for this continuous loss. It makes sense, doesn’t it?

Cancelled By the Dealer:

When you have some open positions and some pending orders at the same time, and the market wants to trigger one of your pending orders while you have no enough free margin in your account, that pending orderwill not be triggered or will become cancelled automatically. Those trader who don’t know what “cancelled by the dealer” is complain when they see that a pending order is cancelled or not triggered. They think that the broker had not been able to carry their orders, because their liquidity providers had no enough liquidity or because the broker is a bad broker. But the the truth is that your pending orders could not be triggered or were cancelled because you had no enough free margin in your account.

There is a margin check that tests for what the MT4 account margin level will be after the trade is open, and if it is within the acceptable limits, it lets the trade through. The threshold for measuring the post-trade margin ratio is set by the broker usually at 120%, meaning that the bridge will calculate what the used margin will be in the MT4 account after the new trade opens, and if the account equity is less than 120% of the post-trade used margin, the trade will fail margin check and will be automatically cancelled by the bridge MT4 dealer accounts. Of course different brokers can have different post-trade margin ratio setting, but it is usually 120%.

How to check your account balance, equity, margin and margin level?

You can see this information by checking the MT4 terminal. Open the MT4 and press Ctrl+T. The terminal will be opened and it shows your account balance, equity, margin, free margin and margin level.

This is how the terminal looks when you have no open position:

And this is how it looks when having an open position:

This can be different in other platforms.

Balance will change only when you close the position. The profit/loss will be added/deducted to the initial balance and the new balance will be displayed.

Balance – Floating Profit/Loss = Equity
$10,000 – $50 = $10,050

Margin = $2,859.52
(200,000 x 1.4300) / 100 = $2,860.00

Equity – Margin = Free Margin
$10,050 – $2,859.52 = $7,190.48

(Equity / Margin) x 100 = Margin Level
($10,050 / $2,859.52) x 100 = 351.46%

OK 

I hope you are not confused. It is very easy to understand. You may need to read the above explanations for a few times to completely digest the terms I explained.

Briefly and in very simple words:

Leverage: Is the bonus you receive from the broker to become able to trade large amounts with having a small amount of money in your account. When the leverage is 100:1, it means you can trade 100 times more than the money you have in your account.

Margin: Is the money that will be placed and engaged in the positions that you take. For example, to buy $1000 with the leverage of 100:1, $10 from your account will be engaged in the position ($1000 / 100 = $10). You can not use this $10 to take any other positions, as long as the position is still open. If you close the position, the $10 margin will be released.

Balance: Is the total amount of the money you have in your account before taking any position. When you have an open position and its profit/loss goes up and down as the market moves, your account balance is still the same as it was before taking the position. If you close the position, the profit/loss of the position will be added/subtracted to your account balance and the new account balance will be displayed.

Equity: Equity is your account balance plus the floating profit/loss of your open positions. For example when you have an open position which is $500 in profit while your account balance is $5000, then your account equity is $5,500. If you close this position, the $500 profit will be added to your account balance and so your account balance will become $5,500. If it was a losing position with -$500 loss, then while it was opened, your account equity would be $4,500 and if you close it, $500 will be deducted from your account balance and so your account balance will be $4,500. When you have no open positions, your account equity will be the same as your account balance.

Free Margin: Free margin is the money that is not engaged in any trade and you can use it to take more positions. You remember what the margin was, right? Free margin is the difference of the equity and margin. At the above example, your position margin is $10. Lets say the equity is $1000. Therefore, your free margin will be $990 ($1000 – $10). If your open positions make money, the more they go to profit, the greater equity you will have, and so you will have more free margin.

Margin Level: Margin level is the ratio (%) of equity to margin. For example, when the equity is $1000 and the margin is also $1000, margin level will be $1000 / $1000 = 1 or in fact 100%. If the equity was $2000, then the margin level would be 200%.

Margin Call Level: Is the level that if your margin level goes below it, you will not be able to take any new position. Margin call level is determined by the broker. When it is set to 100%, you will not be able to take any new position if your margin level reaches 100%. When you have losing positions, your margin level goes down and becomes close to the margin call level. When you have winning positions, your margin level goes up.

Stop Out Level: Is the level that if your margin level goes below it, the system starts closing your losing positions. It will close the biggest losing position first. If this helps the margin level go above the stop out level, no more position will be closed. Then if your other losing positions keep on losing and the margin level goes below the stop out level again, the system closes another losing position which is the biggest one.

Thanks for your time and have a great day/night 

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