LESSON 20. Margin, Leverage, Margin Call, Stop Out
How much money should you have on your account to keep trading? It’s logical that you will need money to maintain open positions.
The necessary sum is called margin. Forex brokers set margin requirements for clients.
Usually, margin equals to 1-2% of the position size. This notion is tightly linked to the term ‘leverage’.
When you trade on margin you use leverage: you are able to open positions on bigger sums than you have on your account.
These small movements can result in larger profits or larger losses when compared to an unleveraged position.
Let’s see how it works on the example. You have $1,000 on deposit and want to trade $10,000.
In this case, 1% margin equal to $100 will be set aside from your account. This is your used margin.
In your terminal “Trade” window you can see columns “Balance”, “Equity” and “Usable Margin”.
Your usable margin will be always equal to “Equity” less “Used Margin.” The leverage is 100:1, because you control $10,000 with just $100.
The remaining 99% is provided by the broker. The margin is needed for broker’s security in case the market goes against your position.
Brokers usually define margin call level.
For instance, if it is at 20%, you’ll get a margin call if your account equity drops to 20% of the margin (in our case 20% of $100 is $20).
In this case, you will receive a warning from your broker that you need to close your trade or deposit more money to meet the minimum margin requirement.
In addition, beware that the broker will have to close your position at the current market price if the ratio of your deposit to your loss will reach so-called stop out level.
If stop out equals to 10%, this will happen if your equity drops to $10 (10% of the margin). Sometimes, margin call and stop out are the same,
and if your drops below 100% of the minimum requirement to trade the position is closed without any warnings.
Margin requirements, margin call and stop out levels are set by the broker for each account type and shown at its website.
As a trader, you should do your best to avoid hitting margin call and stop out levels.