Margin Trading
In this lesson, we will look at something closely related to trading itself, and if you don’t understand this, blowing up your account will be inevitable. It is trading with a margin. In this lesson, we will cover margin and all the other things that will help you efficiently manage your trading business. Because forex trading is much more than just buying and selling currencies, you must be aware of all the nuances that can happen to your account.
Margin trading
You can enter positions bigger than your account balance, thanks to margin trading. So, in theory, you do not need a large amount of money to make a large amount of money in forex trading. Unfortunately, this can be a double-edged sword for many new traders since they can lose a large amount of money even faster. You can think about margin as collateral for your broker, which lets us open the larger position, and your margin is used to cover any losses that might occur. The margin requirement is the percentage amount of margin you must provide when opening a new position. This differs at different brokers.
For example, if you have a 2% margin required on EURUSD, it would mean that for 1 lot, which equals $100,000, you need $2,000 in your margin account to be able to open this position. This 2% or two thousand dollars cannot be used for anything else as long as your position is opened. Once you close the position, these two thousand dollars will be released. Required margin is sometimes also called entry margin, or initial margin, all the same. The required margin is calculated by multiplying a notional value and margin requirements. Using the EURUSD example, you multiply one hundred thousand by zero point zero two, which is the 2% margin requirement and you will get two thousand dollars. If you have multiple positions open at the same time, you might see the term used to margin or total margin. This is simply all margin you are currently using to maintain all positions opened.
The opposite of that is the free margin. These are money that is not locked up in any position, so you can freely use them to trade. When your free margin is at zero or less, you will receive a Margin call saying that you should deposit more money and, of course, cannot open any new positions. Free margin is sometimes called available margin. The margin level displays the percentage ratio between your equity and the used margin. For example, if your equity is $5,000 and the used margin is $1,000, the margin level is 500%.
Account balance and equity
The account balance represents funds which you have deposited to your trading account. It is simply the money you have in your account. So, if you deposit ten thousand dollars to your trading account, your balance is $10,000. If you open a new trade, your account balance won’t change until that position is closed. The only times when your account balance change is when you add more funds, if you close opened positions, or if you hold a trade overnight. As the first two cases are very straightforward, holding positions overnight can get a bit complex. Overnight in forex is called a rollover; during the rollover, a swap is calculated.
Swap is a fee that is either charged or paid to you at the end of the trading day. The balance increases if you are paid swap and decrease if you are charged swap. Equity represents the current value of your trading account. If you have no positions open, your equity equals your trading account balance. But, if you have a ten thousand dollar account balance and currently have opened trade that is on a $1,000 profit, your equity is $11,000. The same goes for negative, if the trade would be running in $1,000 loss, your equity would be $9,000. Equity will constantly fluctuate until all positions are closed. So, it is a real-time calculator of your profits and losses, compared to a balance that only shows profits and losses from closed positions.
This is why we at FTMO care about your account’s equity when you undergo our evaluation process or trade on an FTMO account. It is because the balance does not display a real amount of funds on the account. For example, if you have a $100,000 account, but currently sitting in a floating loss of $90,000, you have only $10,000, not $100,000 as your account balance states.
Floating and Realised PnL
Floating and Realised PnL is closely tied with balance and equity. Floating PnL shows profit or loss in your equity. This is the profit or loss of trades you have currently open. So, if you went long gold at 1,900, but the price is currently sitting at 1,880, it means that you are down 20 points, your floating PnL would be negative depending on your position size. If one point is worth $1, you are down $20, if it’s worth $100, you are down $2,000. If you are down these 20 points and you decide to close the trade, it becomes a realised loss. And If you would be up 20 points, it becomes a realised profit. Realised PnL represents gains or losses that have been converted into your account balance. In trading and everything else, profit is not real until it is realised. Unrealised profits are theoretical paper profits.
Margin call and stop out level
The margin call represents a specific percentage level. When this level is reached, you won’t be able to open any new positions. The margin call level is determined automatically in your trading platform. For example, if your margin call level is 100%, it means, that if your margin level reaches 100%, you won’t be able to open any new position as your account is under margin call. Although a lot of traders think that margin call means that their trades are getting closed. That is not correct.
The margin call gives the trader a warning. Stop out level is the specific percentage level, where, if your margin is equal or below, your broker starts closing your positions until the margin level is greater than the stop out level.
If we say that stop out level is 70%. It means that if the margin level falls below 70%, stop out will automatically occur, and positions with the largest floating loss, will be liquidated. The process is repeated until the margin level increases above 70%.
To recap this, a margin call is just a warning that traders receive when they breach the margin call level. Stop out happens when the stop out level is breached and positions start to get liquidated.
And how to avoid a margin call?
Avoiding a margin call is not hard, all you need to do is follow proper risk management. This includes using stop losses that will get you out of the trade, way before a margin call. But it can occur… in some rare situations where stop losses might not help. During high-impact news and flash crashes, traders could experience slippage, which means that your Stop Loss fills at a much worse price than you expected. These situations cannot be 100% avoided. But traders can prevent them by watching the macroeconomic calendar and using smart money management.
