Margin Trading for Beginners
Margin trading is when you borrow or ‘leverage’ majority of the capital you are trading with from your broker. A lot of brokers offer margins as low as 50:1. This means that you only need to have 2% of the amount you are holding in a position in your actual account. This is a leveraged position.
As discussed before, most trades happen in specific lot sizes. The reason for this is to make reasonable profits even with small changes in pip value. Not everyone will have $100,000 to trade off. To help with this, brokers will allow money to be borrowed from them.
This is not purely from the goodness of their hearts though. The main reason is to earn interest when there’s rollover. All of this has been discussed before, but to summarize when a trader holds a position for more than one business day interest gets involved. For money that is borrowed, interest in paid by the trader to the broker and for currency bought interest is earned.
This is the main mechanism behind margin trading and leveraged positions. There are other things you need to understand to be able to hold such a position though, or even to open an account. Given below is brief explanation of all the terms you need to know.
Margin Requirement and Required Margin
For any position there is a value of margin requirement. It is also called the “notional value”. That is the amount of money that you need to open a position.
Required margin is what gets locked up once you open it and start trading. These values depends on the broker and the position.
Balance is the capital you will open your account with. This is the amount of money you have. When you earn or lose money, this is the figure that changes.
This is the state of your profit or loss coming from a position when it is still open. It is also called Floating P/L. P/L here stands for Profit/Loss. For as long as you have a position open, the currency values have the potential to rise or take a dip. And so your profits and losses can change accordingly and profits can even turn into losses if the market takes a bad turn. Until you close the position, your Profit/Loss remains unrealized.
This is the actual money you make or lose once you close a position. This will be reflected in your account balance, unlike unrealized P/L which was in the air only.
If you put together all the required margins that have been locked up in your account for all your open positions, they will make up the “used margin”. This is money that is already being used for other positions and so is not available.
Your Balance together with Unrealized P/L is basically the Equity. It is the value of your trading account, but don’t confuse it with balance. One good way to differentiate these two is to remember that if you had no open positions, your balance and equity would be the same.
Free margin is the amount in your account that is up for use. This is margin that is not already being used in other trades and so is ‘free’ for investment if you want to open another position.
Margin level is a measure for Free Margin. It tells you how much you have in your account that is available.
Margin Call Level
This is a limit set by the broker. Different brokers have different Margin Call Levels. This is when they restrict your activity. For example, you will no longer be able to open any new positions or in some cases you even expose yourself to the possibility of having some of your positions liquidated. You are now only allowed to close the ones you’re already holding. This level might show that your equity (account value) has equaled the used margin, if your broker has set it up that way. In other words, you are incurring losses. In order to pay those losses you need a certain amount in your account. You now only have that much left (enough for you to close a losing trade), so you have reached the Margin Call Level.
The above example is for when the Margin Call Level is set to 100%. As stated earlier, this is not always the threshold for all brokers.
This is when you have reached the Margin Call Level and get notified by the broker. The broker makes “the call”.
Stop Out Level
This is when your account value depreciates to the point where the broker liquidates all of your positions. This is to ensure that you don’t end up with negative account balance. This level is reached when you have used up your margin to hold positions on which you are now losing.
You now have the basic information you need for margin trading. It does not prepare you fully for the real deal though. You have to actually look at a real trading platform to see how these concepts work in reality.
Nonetheless, we will go on with this education of ours and move on to see what are the best times for you to apply all these ideas and concepts you’ve learned.