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May 30, 2016

Question:What is Margin, Lot Size and Margin Call in Forex Trading?

Answer:

In the Forex market, the term margin is most often referring to the amount of money required to open a leveraged position, or a contract in the market.

It is calculated in 2 ways: Used Margin and Free Margin.

  1. Used margin is the amount of money used to hold open positions.
  2. Free margin is the amount of funds available to place additional positions.

Without margin and leverage, many investors would not be able to afford one standard lot; to open a 1 standard lot USD/CAD position, the trader would need $100,000 or more.

For example, leverage of 50:1 would allow a trader to place the same one lot ($100,000) USD/CAD trade with $2,000 in margin.

It’s worth mentioning that leverage can just as easily work for you as it can against you.

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The Relationship between “Lot Size” and “Margin”

Naturally, the amount of margin required for a trade is directly correlated with the lot size of the trade.

It may seem confusing that a one lot EUR/USD position requires a different margin amount than a one lot GBP/USD position; but it is actually quite simple.

For the sake of example, we assume leverage of 50:1 (2%).

As mentioned on the Contract Sizes page, the lot size is based off of notional value, or the base currency pair.

Let’s say that a trader opens a one-standard lot position on the EUR/USD.

The lot size is €100,000, and the margin requirement is 2%, or €2,000.

To get the margin requirement – since the account is in USD and not EUR – the trader would then need to convert the €2,000 into USD.

All you need to do is multiply the margin requirement, €2,000, by the current EUR/USD rate.

EUR/USD GBP/USD USD/JPY
Lot Size 100,000 100,000 100,000
Margin Requirement €2,000 £2,000 $2,000
Currency Value 1.2345* 1.5678*
USD Margin 2,000 × 1.2345 = $2,469 2,000 × 1.5678 = $3,135.60 $2,000
*Check your trading platform for the most current rates.

As the above table demonstrates, the margin requirement is 2% of the lot size, and is the base currency of the pair you’re trading.

Then, to calculate the USD equivalent, multiply the margin requirement by the current value of the currency pair.

This multiplication isn’t necessary for pairs like the USD/JPY that have the USD as the base pair, because the 2% margin requirement is already in USD.

Multiplying the margin requirement by the USD/JPY rate — as we did for the EUR/USD and GBP/USD examples — would convert the margin requirement into JPY.

MT4 calculates the required margin at the time the trade is opened.

Even though the value of a currency pair fluctuates over time, the margin requirement for any single trade doesn’t fluctuate.

Understanding and Calculating a Margin Call

A margin call warning (and potential liquidation) is triggered if a customer’s account equity falls below the required margin.

In other words, to protect both the customer and the company, safeguards have been put in place to prevent a trader from going into the negative and owing the company additional funds.

During the margin call warning period, customers are encouraged to send additional funds or their position(s) will be closed at market price when a customer’s account equity reached the margin call liquidation level.

Traders will be subject to margin call liquidation at 100% margin level.

It is worth mentioning that, because the forex market often moves very quickly, traders who have a margin call warning usually do not have enough time to post additional funds before the liquidation occurs at the 100% margin level.

The margin level is calculated as:

Equity ÷ Margin × 100 = Margin %

For example, a trader with $2,000 in equity, using $750 in margin, could calculate margin level as such: 2,000 ÷ 750 × 100 ≈ 267%.

At 125% margin level (using the previous example, when equity is $1250 and margin is $1000) a trader is essentially using their entire available margin, and is unable to place new trades.

When this level drops to 125% a warning indication can be seen in the traders platform in the form of their balance bar turning red.

Should the trader not deposit additional funds or free up additional margin, when the account reaches 100% margin level trades will automatically be closed.

Contract Sizes, Margin & Leverage

Understanding contract sizes, otherwise known as lots, is a necessary foundation when understanding the need for high leverage in the Forex market.

Each standard lot traded in the Forex market is a 100,000 unit (of the base currency) contract.

In other words, when trading one lot in a standard account on the USD/CAD for example, a trader is essentially placing a $100,000 trade in the market.

This table helps illustrate the differences between standard lot sizes and a mini lot sizes.

Standard Account Mini Account
Lot Size 100,000* 10,000*
Maximum Trade Size 50 standard lots 50 mini lots
Minimum Trade Size 0.01 standard lots 0.01 mini lots
1 Lot Pip Value $10 per pip $1 per pip
*Based off of notional value. (Notional value means the values are based off of the base currency of the currency pair you are trading. For example, if you’re trading the EUR/USD, then 1 standard lot would be €100,000; and one GBP/USD standard lot would be £100,000.)

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