What is Margin and Free Margin in MT4?
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Entering the forex market means that we need to equip ourselves with much financial knowledge, trading methods, analytical techniques, capital management skills, risk management, etc. But the first and most essential thing that needs to be grasped and understood are the terms related to forex trading. In this article, Investiki explains “What is Margin and Free Margin as well as its related terms in MT4.
What is Margin in MT4?
To understand its definition, you have to relate the leverage ratio in forex trading. The leverage allows investors to place orders with a value greater than their capital. This means both profits and losses are amplified.
For instance, you only have $1,000 in your account but want to increase your position size up to $100,000. It would help if you used leverage. And for your using leverage, the forex broker asks you to deposit an amount which is the Margin.
So, Margin is the minimum amount that an investor must deposit to open a position in the market.
Margin depends on the leverage ratio you use, the leverage tells you how much percentage of the amount you have to deposit to open the order, and that percentage is the Margin Rate. The higher the leverage, the smaller the margin rate and the lower the Margin.
The relationship between leverage and margin rate is shown in the following table:
For example, The USD/CAD pair is quoted as Bid: 1.25500, Ask 1.25580. The account has a leverage of 1:400 and a balance of $500. You want to place a Buy order with a volume of 0.5 lots
Buying 0.5 lots of USD/CAD means buying 50,000 USD (1 lot equals 100,000 units of the base currency). If your account is in USD, there is no need to convert the exchange rate.
You use the leverage of 1:400, equivalent to a margin rate of 0.25%, then the minimum amount you need to deposit or margin to open this trade is 0.25% x $50,000 = $125.
Other terms related to Margin
Some other terms related to Margin you need to know are:
- Used Margin: Each trading order is opened, the trader must deposit an amount of Margin. The total Margin of all open positions is the Used Margin.
- Free Margin: The amount left in the account after deducting the used Margin, free Margin = Equity – Used Margin. Free Margin is also the amount of Margin you can use to open new positions. The lower the free Margin, the less likely it is to open new orders.
- Margin level: is the percentage of the equity to total used Margin. Margin level = (Equity/Used Margin) x 100%. If you do not open more or close fewer running orders, the used Margin will not change. The margin level will only depend on equity.
While open orders are running, the margin level will always change due to the constantly fluctuating equity. After the orders have been matched, the used Margin is lower than the equity. The margin level is > 100%. When orders are running, the order is at a loss. Equity goes down. The margin level goes down. If equity is reduced by used Margin, then margin level = 100%. If lower then margin level < 100%.
Margin level <= 100% means Free margin <=0. At this point, you cannot open any other new orders. When the margin level decreases, you are losing heavily. The account is in an unsafe state, it is necessary to take timely measures to avoid a clean loss (margin level = 0% when equity = 0) or the account is damaged negative (margin level < 0% when equity < 0 ) if the market keeps going against your order. And if after that your order starts to get better, equity will increase, margin level will increase, the account will return to a safe state. A trading account is considered safe when the margin level is > 100%, when this ratio decreases, forcing you to intervene in your account or trading orders to improve it.
To avoid the case that investors do not regularly monitor running transactions or are negligent in not paying attention to the margin level ratio, forex brokers have set a specific limit if the margin level falls below the limit. The exchange will notify traders through an order/warning called Margin Call during this period. They can intervene on time, avoiding the situation of letting the account suffer heavy losses if the market continues to fluctuate opposite direction. Typically, forex brokers often choose a limit of 100%. When the margin level drops below 100%, a margin call occurs.
When a margin call occurs, you will have two interventions to account or open orders to improve margin level:
- Or deposit more money into the account -> equity increases -> margin level increases.
- Either close part or all of the losing positions -> used margin decreases -> equity increases -> margin level increases.
If you don’t intervene in these two ways but are confident that the market will quickly return to the direction expected, the margin level will increase again. However, if the market is still against you, the margin level will continue to fall deeply more, to a limit lower than the margin call, the broker will automatically close all your running orders, including those that are profitable.
Margin trading or leveraged trading gives traders the advantage of amplifying profits on a small amount of capital but comes with correspondingly amplified risks. But one of the characteristics of the forex market is leverage, margin, so it will not be suitable for those who like safety. Therefore, when you have decided to choose forex as a long-term investment channel, you need to know how to accept risks, invest in knowledge and accumulate experience so that risks are always kept to a minimum.
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