There’s another word that you will hear mentioned along with ‘leverage’ and that’s margin. In the leverage article, we mentioned that the broker will need a minimum deposit in order to leverage you.
This minimum deposit is called ‘Margin’. Every time you make a transaction (purchase lots) with the help of your broker’s leverage, your broker will expect you to make a minimum deposit in order to provide you with the leverage.
This Margin will be expressed as a percentage and will depend on how much leverage the broker is giving you for that particular trade.
For instance, let's say that the broker gives you a 100:1 leverage and a margin requirement at 1%. This means if you’re purchasing a lot worth $10,000, you will have to put up 1% ($100) while your broker fronts you the rest.
Similarly, the margin requirement could be 2%, .5% or .25% depending on the lot you’re trading, the currency pair and your broker’s policy on margin trading and margin accounts.
When you trade with a margin account, it is important to understand two concepts: Used margin and Usable Margin. Failure to understand and keep track of these two concepts leads to what is called as a ‘Margin Call’ – which is a very unpleasant experience among Forex traders.
Let’s say you open an account with your broker for $10,000. This is called your ‘equity’. You want to buy a lot worth $100,000 for which your broker asks for 1% margin requirement (100:1 leverage). Thus, you will be paying $1000. The remaining amount in your account, i.e. $9000 is called your Usable margin.
This Usable margin will be used to open further positions (make more transactions/purchases) or to bear losses. Before buying that lot worth $100,000, your Usable margin was $10,000.
Used margin, obviously, is the amount ‘used’ or currently ‘locked’ in transaction. In the above example, for the time that you hold on to that lot of $100,000, your $1000 is the ‘Used’ margin.
A ‘margin call’ happens when your usable margin is not enough to cover the margin requirement of a particular transaction. For instance, had you only had $1000 in your account, then on a 1% margin, in order to buy $100,000 you would have to pay up the entire $1000.
Thus you have no usable margin to open up further positions or to suffer losses. At this time, your broker will ask you to deposit more money in the account, or close some positions i.e. sell off certain lots, regardless of whether you make a profit or loss.
Usable Margin = Equity – Used Margin
Used Margin = Equity – Usable Margin