Learning Some Very Important Terms in Forex Trading Is a Must before Risking Any Money: Leverage, Margin, Balance, Equity, Free Margin, Margin Call and Stop out Level
I always see that so many traders who trade forex, don&8217;t know what margin, leverage, balance, equity, free margin and margin level are.
As a result, they don&8217;t know how to calculate the size of their positions.
Indeed, they have to calculate the position size according to the the risk and the stop loss size.
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 it has to be calculated, and the role of leverage in margin.
In order to understand what margin is in Forex trading, first we have to know the leverage.
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What Is Leverage?
&8220;Leverage&8221; is a feature offered by the brokers.
It is like an special offer indeed.
It helps the traders to trade the larger amounts of securities through 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 was just an example to understand what leverage means.
I know that nobody pays US dollar to buy US dollar 😉
A small exercise:
How much do you have to pay to buy 10 lots USD through 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.
What Is the Required Margin?
Margin is calculated based on the leverage.
But to understand the margin, let&8217;s forget about the leverage for now and assume that your account is not leveraged or its leverage is 1:1 indeed.
&8220;Required Margin&8221; is the amount of the money that gets involved in a position or trade as collateral.
Let&8217;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?
Let&8217;s assume that the EUR/USD rate is 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
€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 be locked in this position as collateral.
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 &8220;locked money&8221; which is $1,431.4 in this example, is called Required Margin.
&8211; If You Close Your Position
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&8217;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 position with an account with the leverage of 100:1, how much margin will be locked in this trade?
One lot EUR/USD = 100,000 Euro against USD
EUR/USD rate: 1.4314
100,000 x 1.4314 = 143,140.00
One lot EUR =$143,140.00
Margin = $143,140.00 / 100 = $1,431.40
Therefore, to have a one lot EUR/USD position with a 100:1 account, a $1,431.40 margin is needed, while the EUR/USD rate is 1.4314.
This needed $1,431.40 margin is called &8220;required margin&8221;.
You can use the below margin calculator to calculate the required margin in your trades:
What Is the Account Balance?
When you have no open positions, your account 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 positions, your account balance is $5000.
What Is the 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 is $1,500 in loss, then your account equity would be your account balance minus $1,500.
What Is the Free Margin?
Free margin is the difference of your account equity and the open positions&8217; required margin:
Free Margin = Equity &8211; Required Margin
When you have no positions, no money from your account is used as the required margin.
Therefore, all the money you have in your account is free.
As long as you have no positions, your account equity and free margin are the same as your account balance.
Let&8217;s say you have a $10,000 account and you have some open positions with the total required margin of $900 and your positions are $400 in profit.
Equity = $10,000 + $400 = $10,400
Free Margin = $10,400 &8211; $900 = $9,500
What Is the Margin Level?
Margin level is the ratio of the equity to the margin:
(Equity / Margin) x 100
Margin level is very important.
Brokers use it to determine whether the traders can take any new positions when they already have some positions.
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.
What Is the 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 required margin:
Equity = Required Margin => 100% Margin Call Level
It happens when you have losing position(s) and the market keeps on going against you.
As a result, when your account equity equals the margin, you will not be able to take any new positions anymore.
Let&8217;s say you have a $10,000 account and you have a losing position with a $1000 required margin.
If your position goes against you and it goes to a -$9000 loss, then the equity will be $1000 ($10,000 &8211; $9,000), which equals the required margin:
Equity = $10,000 &8211; $9,000 = $1000 = Required 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 required 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 and policies for this too.
This limit is called Stop Out Level.
What Is the Stop out Level?
For example, when the stop out level is set to 5% by a broker, the system starts closing your losing positions automatically if your margin level reaches 5%.
It starts closing from the biggest losing position first.
Usually, closing one losing position will take the margin level higher than 5%, because it will release the required margin of that position, and so, the total used margin will go lower and therefore the margin level will go higher.
The broker&8217;s 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 cannot allow you to lose more than the money you have deposited in your account.
The market can keep on going against you forever and you lose all the money you have in your account and then get a negative balance if nobody closes your losing positions.
If you don&8217;t pay the negative balance, the broker has to pay it to the liquidity provider.
As it is almost impossible to take the loss from the trader, brokers close the losing positions when the margin level reaches the Stop Out Level, to protect themselves.
Cancelled By the Dealer:
Imagine you have some open positions and some pending orders at the same time
Then the market reaches where one of your pending orders are placed while you have no enough free margin in your account.
Therefore, the pending order will not be triggered or will become cancelled automatically.
This is called &8220;Cancelled by the Dealer&8221;.
The traders who don&8217;t know what &8220;cancelled by the dealer&8221; is, will 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 one.
But the the truth is that the pending orders could not be triggered or were cancelled because there was no enough free margin in the account.
You have to have free money in your account to take a new position. When you don&8217;t, you can&8217;t take any new positions.
There is a margin check that tests for what the MT4 account margin level will be after the trade is open.
If the the MT4 account margin level is within the acceptable limits, it let&8217;s the trade through.
The threshold for measuring the post-trade margin ratio is set by the broker usually at 120%.
It means that the bridge will calculate what the used margin will be in the MT4 account after the new trade opens.
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 have different post-trade margin ratio settings, but it is usually 120%.
What Do You Have to Calculate on Your Own?
You don&8217;t have to calculate any of the above parameters that I explained above, because the system calculates them automatically.
However, you have to know what they are and what they mean.
As I explained above, the only parameter that you have to calculate, is your position size that has to be calculated based on the stop loss size of the position you want to take, leverage, and the percentage of the risk you want to take in that position.
You can use our position size calculator to do that.
How to Check Your Account Balance, Equity, Margin and Margin Level?
You can see all of these parameters 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 a position.
The profit/loss will be added/deducted to the initial balance and the new balance will be displayed.
Balance &8211; Floating Profit/Loss = Equity
$10,000 &8211; $50 = $10,050
Margin = $2,859.52
(200,000 x 1.4300) / 100 = $2,860.00
Equity &8211; Margin = Free Margin
$10,050 &8211; $2,859.52 = $7,190.48
(Equity / Margin) x 100 = Margin Level
($10,050 / $2,859.52) x 100 = 351.46%
I hope you are not confused.
It is very easy to understand the above terms and parameters.
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:
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.
Or, you can trade 100 units with one unit of you account balance.
&8211; Required Margin:
Is the money that will be placed and locked in the positions that you take.
For example, to buy $1000 with the leverage of 100:1, $10 from your account will be locked 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.
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 to or deducted from your account balance, and the new account balance will be displayed.
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.
&8211; 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 or required margin was, right?
Free margin is the difference of the equity and the required margin.
In the above example, your position margin is $10.
Let&8217;s say the equity is $1000.
Therefore, your free margin will be $990 ($1000 &8211; $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.
&8211; 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%.
&8211; Margin Call Level:
Is the level that if your margin level goes below, you will not be able to take any new positions.
It is the broker who determines the Margin Call Level.
When Margin Call Level setting is 100%, you will not be able to take any new positions if your margin level reaches 100%.
While having 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.
&8211; Stop Out Level:
Is the level that if your margin level goes below, the system starts closing your losing positions.
It closes the biggest losing position first.
If this helps the margin level go above the stop out level, then it doesn&8217;t close any more positions.
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 open losing position.