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A margin call is a term that can evoke a sense of trepidation and even vulnerability among FX traders, particularly for new traders and investors. Thus, to help sidestep the prospect of a margin call, the first step involves understanding what margin is in the Forex space and its relationship with leverage. Traders and investors can then employ risk-management strategies to help circumvent the possibility of receiving a margin call.
Forex trading, or foreign exchange trading, involves trading one currency against another, hence the term currency pairs. The FX market is the largest financial market globally, with OTC (Over the Counter) turnover reaching a staggering US$7.5 trillion per day in April of 2022, according to the latest Triennial Central Bank Survey (OTC foreign exchange turnover in April 2022).
For those new to currency trading, the Forex market is grouped into three defined types of currency pairs: Majors, Minors and Exotics. Majors are the most widely traded currency pairs, boasting high liquidity and narrow spreads. Popular pairings are EUR/USD and AUD/USD.
Forex traders commonly employ a margin account to trade FX products, allowing market participants to leverage their capital. Without it, trading FX markets would be difficult and expensive, given the trading capital required to trade the equivalent of even a Mini Lot (10,000 units).
Margin and leverage are linked in Forex. Leverage is accessed through trading on margin (margin trading), a concept often described as having the ability to increase exposure through margin greater than one’s account equity. Note that while this can increase returns, it can equally increase potential losses. To be clear, leverage in the FX market is not funds borrowed from the brokerage. You are not dealing in physical shares; this is the derivatives market where, in the case of Forex and CFD brokers, CFD (Contract for Difference) contracts (agreements) are traded, which involves two parties trading on the underlying price movement in the OTC market.
Margin in the Forex market is essentially used as collateral to safeguard the two parties in the trade. Think of it as a good-faith deposit to execute the trade (however, this deposit is normally returned once the trade is liquidated). Leverage, as noted above, is created through the margin used. If we use 1,000 USD margin to trade a position equivalent to 100,000 USD (possible with a leverage ratio of 100:1), we have effectively traded 100 times our margin and therefore leveraged the capital in our account.
Absent of margin accounts in FX, many retail traders would be unable to participate in the Forex market. Think about it. 100 pips equate to 1 cent, 1,000 pips equals a 10-cent move, and 10,000 pips denotes a move of only 1 USD (assuming the quote currency is priced in dollars). So, just to put this into perspective, you would need at least 10,000 USD to trade the equivalent of 1 Mini Lot, whereas trading on margin, you could trade an equivalent position for much less (usually between 1-3% of the notional amount, so 100 USD to 300 USD in the case of a Mini Lot).
Calculating the margin requirement for a specific trade depends on the account currency, the currency pair and the units traded (calculated through position sizing). If the account currency is the same as the quote currency of a currency pair, for example, the calculation involves multiplying the units traded by the exchange rate of the currency pair traded and then multiplying the resulting value by the margin percentage. Now, the margin percentage is derived from the leverage ratio, which should, by now, make logical sense. For instance, 100:1 leverage offers a margin percentage of 1%, found by dividing 1 by 100 (0.01 or 1%). For those seeking a Forex calculator, consider checking out the dedicated FP Markets Forex calculator.
Another key point to remember is that higher (lower) leverage equals a lower (higher) margin requirement.
It is also worth highlighting that you can calculate what’s known as True Leverage: the notional value of the currency trade divided by your account equity. By way of an example, if you are trading a 200,000-unit position on EUR/USD (2 Standard Lots) with 10,000 USD in account equity, the true leverage, in this case, is 20 = (200,000 / 10,000).
A margin call occurs when a trading account’s equity equals the margin, meaning free margin is zero and no additional positions can be opened. You will not receive a margin call if the trading account’s equity balance remains above the margin used.
To be clear, Forex and CFD brokers, including FP Markets, will usually email a trader who has reached a 100% margin Level (where equity equals margin), and the terminal strip will turn red. It is a request by the broker to add more funds to bring margin deposits up to the initial margin level to keep existing positions open. However, in the event of further loss to an account where your equity dips under the margin, you are in danger of hitting the broker’s stop-out level, which is set to 50% for FP Markets. For example, if the margin is 1,000 USD, the stop-out level would be 500 USD. Hitting the broker’s stop-out level would see the brokerage automatically closing some open positions in the trading account.
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