Forex is a hot topic for people who want to invest and make it big. It’s general knowledge that forex trading is not without significant losses and gains. As usual, it is advisable to research forex trading and get a substantial amount of training to avoid losses. While learning about forex trading, you might have come across margin and free margin.
Before you understand the meaning of free margin, it is essential to know the importance of margin. From this in-depth review, you would find out that individuals have to trade in the forex exchange market with the help of forex brokers. Forex brokers trading on behalf of these individual forex traders means that the trade risks are on the broker. Margin is the amount of money that the trader deposits with the broker that serves as security for trading risks. The maximum leverage a forex trader gets trading in an account depends on the margin the forex broker requires. Due to the risks involved, some forex brokers offer to help traders stay afloat in trading. These bonuses help in increasing the free margin.
It is essential to know that the margin maximizes output. If you are going to lose, the loss will increase due to margin. The same goes with profit; margin maximizes profit. It is also vital to know that there are two types of margin in forex trading. We cannot explain one without explaining the other. The two types of margin are the used margin and the free margin. A used margin is relatively self-explanatory. Used margin is a needed margin that is still under lock due to its use in open positions. The free margin, on the other hand, is not under lock but available for use in a trade or for securing positions.
Meaning of free margin in forex
In forex, free margin is a usable margin or an available margin. A free margin is also known as a Usable maintenance margin. Just as the used margins secure previous positions, similarly, free margins can be collaterals for securing new positions. With that amount in the free margin, you can ensure the previously reserved positions with the used margin. Meaning with free margin, you can get a double amount of protection for your spots for a reasonable period before you get a stop out or margin call.
Forex trading has numbers as its prime figure, mainly because we are trading currency, which would require calculation. Mathematically, free margin is the used margin subtracted from equity. Equity is relatively easy to understand. Equity is the balance of the trading account. As the balance of the trading account, it includes floating loss and profits of the positions in that account that are still open. Mathematically, equity is the account balance of the trading account added to the floating profits and losses.
Application of free margin
1. An increase in equity leads to a rise in free margin: Trading is like buying positions on the forex market. For a trade to continue, the positions have to be still open. If the positions available are profits, then the equity level would increase. These potential profits are known as floating profits in forex trading. An increase in the equity of a trading account leads to a direct increase in the free margin. These indicators indicate a potential profit at the end of the trade.
2. A decrease in equity leads to a reduction in free margin: If the positions still open in the trading account are full of potential losses, it only means that there would be a significant decrease in the equity. Potential losses are known as floating losses. The decline in equity would lead to a reduction of the free margin. The reduction in free margin and equity signifies a potential loss in that particular trading session.
The margin level of a trading account is directly proportional to the equity. With good equity in a trading account, the margin level is sure to be healthy. The healthiest margin level is at a hundred percent. A margin level below fifty percent is unhealthy. The margin level is calculated by dividing the equity by the used margin and multiplying by 100. If the margin level falls way below healthy percent and there is no free margin as leverage, there would be a margin call or stop out. A stop-out is like a nightmare for every forex trader.
Free margin is as essential as the margin itself in forex trading. There is no guarantee for profits all through the period of trading. There will be times when there will be more floating losses than floating profits, leading to a decrease in equity. The decline in equity causes a reduction in free margin.
The margin level will decrease if the market moves in an opposite direction from your position. However, with free margin, if the margin level of the positions falls below a healthy level, free margin can be used as leverage to stay in the position and not get a stop out.